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Asset Allocator

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Discretionaries buy into fund firms' consensus bets; A gnashing of teeth over UK income

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Great minds...

As uncertainty reigns, asset managers have been grudgingly backing bonds and heading back to the familiar comforts of US equities. Our latest model portfolio data indicates DFMs have been doing something similar.

Analysis of MPS changes in June shows that wealth managers have continued to up their fixed income allocations - a process which began in earnest earlier this year - while displaying little appetite for most risk assets. 

As with their asset manager peers, allocations to UK, Japanese and emerging market equities have all dipped in recent weeks. US equities are again the exception. The typical DFM now allocates 15.2 per cent of their Balanced portfolio to the asset class, up from 14.8 per cent a month before. 

Market movements will account for some of that rise, but as in the past it’s notable that discretionaries were happy to let these positions drift higher - in contrast to equity weightings elsewhere.

On bonds, it’s a similar story: dedicated investment grade debt holdings have been on the increase. But despite fixed income prices moving in tandem with equities, wealth managers have also been happy to dial down their diversification plays. 

Cash weightings dropped back from 5 per cent to 4.5 per cent last month. There’s also no end in sight for the big trend of the past nine months: allocations to absolute return strategies and hedge funds fell further still in June, and now account for just 8.5 per cent of the average Balanced portfolio. 

But while the travails of such funds need little introduction, opinion on the asset class is more divided than some may think. Tomorrow we’ll take a closer look at how exactly different DFMs approach their alternatives allocations.

Payout pleasures

The latest Link UK Dividend Monitor has brought much gnashing of teeth about a sagging rate of underlying payout growth. Equity income managers, always keen to emphasise that only their strategy can guide investors through the coming storms, have spoken of the need to be selective. But the reality is that choices are relatively simple for income investors as it stands.

The data shows it is small and mid-caps that are feeling a particular strain at the moment. Large-cap companies have fared somewhat better, driven by special dividends and FX movements. 

It’s true that the biggest ‘dividend traps’, whose subsequent cuts to their payouts can have a significant impact on the dividend report's headline figures, tend to be large-cap companies. But firms that pare back payouts tend to be well-flagged nowadays: few will be surprised if Centrica, for example, cuts back next week.

Then there is sterling. The pound has dipped ahead of Boris Johnson’s arrival as prime minister, but few think it is yet pricing in a no-deal Brexit outcome. Conversely, the best-case scenario for those opposed to Brexit is a further delay, not an immediate resolution: hardly a recipe for a big rally. 

So sterling risks still look to be skewed to the downside. If so, the biggest UK dividend payers are in little danger of being caught out by a rebounding pound any time soon. Corporates may not be in the best of health, but the problem areas are not as widespread as some might think. 

While active managers tend to be structurally underweight large caps, most equity income managers still have a sizeable enough exposure. Those managers are still confident in their ability to deliver for investors, and in truth it should indeed still be possible to eke out reliable dividend growth for some time yet.

Small stakes

Another relatively common concern for smaller company funds - liquidity risk - also has a particularly UK relevance in the current climate. Look no further than research from MSCI, which analysed 400 £1bn-plus funds and found a handful were notably illiquid.

The research provider based its analysis on US rules that prevent funds from holding more than 15 per cent of their portfolios in illiquid assets - securities where it would take more than a week to sell 5 per cent of the holding in normal market conditions. 

No such rules exist on these shores, but aberrations are rare nonetheless.  The biggest culprit, inevitably, was Woodford Equity Income. 

Seven other funds also breached the limit, though there are only two strategies that rival Woodford. This pair each has around 60 per cent of assets in stocks defined as illiquid - and the understanding is these are sterling-denominated smaller company funds. MSCI is staying tight-lipped on the exact identity of these portfolios, but fund selectors’ own research may well have led them to similar conclusions in recent weeks.

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