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Asset Allocator

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DFM income plays come full circle; A submerged opportunity reaches wealth managers

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Two steps forward

It's clear by now that DFMs will end up harbouring fond memories of early 2019. That’s an effect not just of the lower equity valuations that were available, but also the corresponding bond market rally.

Several months later, strong market performance has flattered portfolio returns but leaves less room for manoeuvre when it comes to the large group of DFMs running income strategies. With prices rising and yields falling, how do income-focused portfolios stack-up now?

For a sense of what’s on offer, we’ve parsed the Income offerings in our MPS tracker to see where portfolio yields stood at the start of Q3 versus the payouts available at the end of September last year. The chart below gives a snapshot of our findings:

While all of the income models in our database unsurprisingly saw yields rise on the back of the Q4 sell-off, portfolio idiosyncrasies have meant greater dispersion further down the line. At the start of Q3, two thirds of the income models in our database were still clocking up higher yields than they had prior to last year's volatility.

DFMs still continue to vary significantly when it comes to the yield they offer. But what’s more striking is how much they have in common: whether they now yield more or less than at the start of Q4, most Income models haven’t seen a big shift. For many, the change amounts to tens of basis points.

So having grasped a silver lining at the start of this year, DFMs are roughly back to where they started as far as income is concerned. For those wanting to reach higher, a more tactical approach might look tempting.

Submerged market

Vietnam is proving a rare winner from the US-China trade war. That's received wisdom at this point; we alluded to it ourselves back in May, though the country is typically beyond the purview of the average asset allocator.

But the south-east Asian nation's growing attractions have led some emerging market fund managers to jump onboard. The FT's EM Squared service points to data from Copley Fund Research showing that a record one in five emerging market funds now has exposure to Vietnam - despite the country not being part of the MSCI benchmark.

DFMs' selections are ahead of the curve on this point: two of discretionaries' top five emerging market picks, as judged by our database, have positions in Vietnamese stocks.

These weightings typically aren't enough to move the dial: Copley says the average EM fund still has just 0.3 per cent in the country. The two DFM favourites, run by Goldman Sachs and RWC, had 0.9 per cent and 1.4 per cent, respectively, as of their most recent accounts.

But what of the Asia ex-Japan funds that wealth managers increasingly prefer to mainstream EM portfolios? The FT story notes that the Baillie Gifford Pacific fund is running a hefty 11 per cent position in Vietnam. But here there are few equivalents among discretionaries' top fund choices. 

Just one key DFM selection, Schroder Asian Alpha Plus, has any exposure at all. Manager Matthew Dobbs has invested via the Vietnam Enterprise Investments trust, one of three London-listed investment companies focusing on the country. Wealth managers looking to tap into the trade war might be best off taking a similar approach.

Sub zero

The rise of Vietnamese assets might be a boon for beleaguered emerging market investors, but it’s not the only reason for cheer in the region this year.

Take emerging market debt. When judged by IA sector averages, a typical emerging market bond fund has outperformed the equivalent investment grade, high yield and strategic bond offering over 2019 so far. Even funds in the UK Gilts and Global Bonds categories, both beneficiaries of the powerful sovereign debt rally, have lagged EMD names in both sterling and local currency terms.

But wealth managers would do well to consider locking in some of these gains. As the FT discusses today, even some emerging market debt has now fallen into negative yield territory. And it’s not just government bonds in the sub-zero club: around a fifth of negative-yielding EM debt comes from corporate issuers.

EM has long been a world for careful stock (and bond) picking. But for anyone with a nervous disposition about prices or a thirst for yield, an even more selective approach now looks wise.

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