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Wealth firms bound together in 'fat and flat' era; 60/40 persistence goads allocators

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Holding patterns

Analyst notes can be like buses. But when two different strategists arrive with the same offering in the same week, it might be time to jump on board nonetheless. 

The subject on their minds will be a familiar one to DFMs: both Gavekal Research and Goldman Sachs think that range-bound markets aren’t going away in the near future. As our own research on wealth managers’ asset allocations shows, many discretionaries have similarly found little reason to change things in recent months.

For Gavekal, this persistence stems from three particular assets. For all its volatility, the oil price has typically stayed close to $55 a barrel for four years. At the same time the US dollar index, despite the climbs seen since early 2018, has traded narrowly around the 97 mark. And US Treasury yields, for all the changes in monetary and fiscal policy seen in the US, have remained in a 1.5 to 3 per cent trading range since 2012.

According to the analysts, this means investors are in “the age of range trading”. It’s only US equity outperformance that’s lifted global indices of late: most other markets are “broadly trendless”.

Goldman, meanwhile, says its own risk appetite indicator has been stuck between 0 and 1.5 for six months - the longest such period since the 1990s. That’s a symptom of markets that have been stuck in a “fat and flat” range since early 2018. Sentiment may have shifted this year, but growth worries have been offset by slightly looser monetary policy. 

What could change things? Only a meaningful uptick in growth, Goldman implies. Absent this, any market rotation - which, similar to that seen in early September, may be kickstarted by higher real yields - could prove shortlived.

Absent that growth, markets remain vulnerable to negative shocks, which means trading ranges could get “fatter”. Gavekal, meanwhile, sees little that will shake either Treasuries or the dollar out of their current ranges. Its most confident prediction is another that will resonate with DFMs: while trading ranges may persist, US shares are less likely to stand out for allocators in future. When it comes to investment returns, lower for longer might start to mean flatter for further in 2020.

Not dead yet

Bank of America Merrill Lynch analysts struck a familiar note of their own earlier this month via their “The End of 60/40” research paper. It’s almost a year since we last discussed strategists’ variation on this theme - and the intervening period again hasn’t been kind to the theory. 

Bonds have enjoyed their best six-month period since 2011, and our own analysis shows discretionaries have been happy to buy back into government debt this year as a result. 

This kind of behaviour is picked up by the Baml analysts: they note that while 60/40 trends have worked well, the way in which investors use such allocations has shifted: “many investors now buy equities not for future growth but for current income, and buy bonds to participate in price rallies”. 

Few think these trends are sustainable. But thoughts were much the same in 2018, 2017, 2016 and further back. Baml analysts, it should be said, do admit that it “may not yet be time to get out of Treasuries”. 

But they do offer some alternatives for when the time comes. One is buying higher-yielding dividend stocks in cyclical sectors. Given momentum trades and, inevitably, bond proxies are increasingly correlated with bond yields, underowned shares may well fare better.

The other is buying short duration high-yield debt and floating rate loans. The former is another tried and tested strategy for DFMs, and is far from an unloved trade. Given where growth is, credit spreads are tighter than usual, according to the Goldman note mentioned above. That’s in part because of the reach for yield. But Baml says borrowers’ declining leverage rates should stand them in good stead. 

Floating-rate debt is more of a contrarian trade, given recent trends - but UK wealth managers haven’t been averse to buying in to this area either. The question is whether they think a 60/40 breakdown is more likely than another spell of range-bound markets. At the moment, the sense is that DFMs are happy to sit in the latter camp.

Toughening up

A speech given yesterday by the FCA’s strategy and competition head will have been met with a mixed reception by the funds industry. 

Asset managers conscious of their growing disclosure requirements will have noted that Christopher Woolard admitted their impact can be limited - despite the fact they’ve made up “the bulk of [the FCA’s] requirements” over the past two decades. 

Wealth managers who still find it difficult to get the necessary information out of fund firms will agree with that sentiment. But Mr Woolard’s point, as highlighted by Ignites Europe, is more to do with how little attention is paid by consumers to these disclosures.

As a result, he suggested that the regulator may simplify such demands in future. Yet more stringent requirements could soon follow in other areas. In the words of the speech: “Far better, cheaper and more effective to go for the ‘tougher’ remedy sooner.” Cards may soon be marked in a different way altogether.

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