Dry powder

The search for real diversification has not got any easier of late. Bonds are unequivocally expensive on most metrics. Absolute return and hedge fund strategies have flattered to deceive during recent drawdowns. Access and liquidity remain important issues for a number of other alternatives. 

The summer jump in gold prices owes much to these conundrums. But the precious metal has plenty of detractors of its own. And so, faced with a selection of potential diversifiers that are variously overvalued, unreliable or illiquid, some wealth managers are taking a different tack. 

FTAdviser’s Financial Adviser Forum, held in Birmingham yesterday, was notable for the sight of two investment managers independently voicing the same opinion on this front. Both Jean-Paul Jaegers, head of asset allocation at Barclays Investment Solutions, and Dan Kemp, CIO at Morningstar IM Europe, said they were choosing instead to dial down risk assets and raise cash levels.

“If insurance is expensive, you need to take less risk” was the prevailing wisdom. That will chime with other DFMs, many of whom have also been running elevated cash positions.

This tactic could bring issues of its own for those who run risk-rated models. Dialling down risk must be done on a proportionate basis - and a world of elevated valuations can make it tough to decide where that risk really lies. 

Still, higher cash weightings look sensible at a time of increased nervousness. There’s a lot to be said for the certainty it provides - even if that certainty ultimately translates into losing money in real terms. 

It should be emphasised that cash levels aren't necessarily being hiked because of fears that a crash is coming. Be that as it may, if a significant drawdown for risk assets does arrive, many discretionaries will be happy to have positioned themselves in this manner.

In it for the long haul

Fund managers, too, are holding elevated levels of cash - though there are signs some are beginning to ease off. The latest Baml global fund manager survey shows that average cash levels fell back from 5.1 to 4.7 per cent in September, roughly in line with long-term averages. 

Cash positions among fund managers in Europe fell more significantly, from 5 to 3.5 per cent, and are now below average levels. Some investors are, at least, finding pockets of value.

That’s despite economic sentiment getting gloomier still on the month. Equity allocations may have ticked higher, but the proportion of managers globally who expect a recession over the next 12 months has now reached its highest level in more than a decade. 

On top of that, downbeat views of the US-China trade war are also spreading. Some 38 per cent of managers surveyed now believe the dispute is a new normal and “won’t be resolved”. 

That’s significant, because it means there’s a rival to an increasingly popular theory among investors of late: that the 2020 US presidential election will be preceded by a cessation of trade war hostilities.

Per Baml, 30 per cent of managers think that scenario is the most likely. Instinctively, that feels like a logical position. The need to secure re-election often plays havoc with politicians’ stances in the run up to polling day - particularly when that run-up is as lengthy as the US electoral cycle is. 

So it’s probably a sign of the pervading gloom -  as well as a recognition that political incentives are no longer so easily comprehensible from an economic standpoint - that fund managers are tending on the cautious side for now.

On the slide

This morning’s larger-than-expected fall in CPI inflation, to 1.7 per cent in August, feels immediately outdated: it’s easy to assume that the spike in crude oil prices will soon push prices up again.

Not everyone agrees, however. Capital Economics estimates that the oil price rise, if sustained, will add just 0.1 percentage points to inflation by the end of the year. And there are downside risks to that forecast if Saudi Arabian output recovers relatively quickly.

There's another development that economists predict will put upwards pressure on headline inflation figures: core inflation growth, driven by wage growth. But there’s little sign of that just yet either: “the risk to [this] view, which was borne out in today’s release, is that core services inflation fails to pick up pace, as strong wage growth suggests it should”, says Capital’s Andrew Wishart.

That suggests today’s CPI drop, to a three-year low, might prove more sustained. Disinflationary pressures are still a feature of the UK economy.