Asset AllocatorJul 22 2019

Old favourites resurgent as caution reigns; The alt income boom still shunned by DFMs

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Sentiment shifts

DFMs might be forgiven for thinking that the second quarter was pretty unremarkable, all told. A blip in May was sandwiched between two decent months for risk assets, ensuring the first half of the year ended on a serene enough note.

What that progress meant, however, is that valuations climbed higher once again. And our latest analysis of fund firms’ allocation views shows they've become more nervous over prospects for a number of different assets. The chart below collates Q3 outlooks from a range of different groups, and shows the prevailing sentiment on 10 separate asset classes.

Compare this data with the same asset managers’ positioning at the start of Q2, and there’s evidence that firms have grown more cautious as indices rise. Positive sentiment on UK, Japanese and EM equities, as well as EM debt, has fallen back over the past three months. 

By contrast, rising bond prices have led to greater optimism over some fixed-income safe havens. Although no firm can bring themselves to say they are outright positive on either government or investment grade debt, the proportion who view the latter negatively has fallen sharply. Around 75 per cent were negative at the end of March, but as it stands that figure has dropped to just over 40 per cent.

There are areas where risk appetite is on the up. High-yield bonds are attracting more interest; almost 80 per cent of asset managers in our sample are now positive or neutral, up from less than 60 per cent last time. 

In equities, negative sentiment on European shares has also fallen back. But it’s the old favourites, US stocks, that have seen the biggest rebound. Almost half of fund firms are now outright positive again, compared with around a quarter three months ago. Valuations are rising, and a difficult earnings season may be around the corner, but the world’s largest stock market is still pulling in the plaudits as the decade draws to an end.

Lending their way

Institutional investors are piling into direct lending funds: FTfm notes that Alcentra and BlueBay were among the big winners in the first half of the year as asset managers look to fill the void left by banks.

The £11bn raised by such funds between January and June comes despite lenders facing a problem that has dogged their predecessors in the recent past: finding enough quality borrowers to whom to lend. Figures from Prequin show European direct lending funds are holding record amounts of cash at the moment.

In the UK, direct lending investment trusts have been around for a little longer than many European counterparts. Their record is mixed, though assessments partly depend on how broadly observers define the ‘direct lending’ asset class: some include everything from P2P to infrastructure debt.

Of the handful of trusts that do unequivocally fall into the direct lending category, the most obvious current laggard is Hadrians Wall, which trades on a discount to NAV of more than 14 per cent. Strategies like RM Secured Direct Lending are still on premiums, but there’s little evidence that DFMs are joining the rush to this particular group.

Illiquid strategies like these will always find more of a home in bespoke portfolios rather than models. But the latter do give an insight into where wealth managers are finding value. The answer is a specific part of the direct lending universe - infrastructure debt. Our fund selection database shows trusts like GCP Infrastructure and Sequoia Economic Infrastructure Income are much more popular than those which lend to a range of different businesses. 

There are obvious reasons why DFMs are more comfortable with the former: such strategies tend to focus on larger borrowers, and infrastructure in general has been a fruitful source of returns in recent years. The conclusion is that, for discretionaries, the direct lending boom is concentrated on one specific area alone.

Tech no notice

There’s an enduring sense that thematic equity funds are undervalued by investors of all stripes: from retail investors to wealth managers, geographic approaches to asset allocation are still dominant. That’s particularly the case when it comes to technology funds - many buyers content themselves with US equity plays instead, given the way technology stocks now dominate many US indices. 

In truth, our database shows that DFMs are perfectly prepared to include dedicated tech funds in their portfolios. And Investment Association statistics show that the average technology strategy has enjoyed a higher level of inflows over the past year than the typical fund in any other sector. 

Be that as it may, only the (fool)hardy investor would be interested in backing China’s new Star Market at the moment. It’s been dubbed Shanghai’s answer to the Nasdaq, and who’s to say that won’t ultimately be the case. As it stands, the first 25 companies to list on the exchange gained an average of 140 per cent on the opening day. China’s goal is to show its domestic companies can thrive without the help of overseas indices. Western investors, for their part, won’t feel they’re missing out if those first-day gains are a sign of the volatility to come.