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Asset Allocator

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Fund firms' hostile attitudes start to thaw; DFMs dodge a potent mix of bad news

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Heads turn

As November draws closer, it won’t be long until investors are hit with a familiar barrage of year-end outlooks. But there are fourth-quarter views to consider before that - and, after 10 months of an uneasy rally, there are signs of a new consensus starting to emerge on assets both loved and hated.

The chart below, summarising fund firms’ asset class views at the start of Q4, gives a flavour of that shift.

Minds should first be cast back to the start of the previous quarter: a point marked by caution as fund firms stepped away from UK, Japan and EM equities. Three months on, the same still applies to emerging market equities amid disappointing returns. But lower valuations in the UK and Japan have produced a slightly more positive outlook in these cases. Asia and Europe are also attracting greater support, although enthusiasm for US equities has fallen back.

By contrast, fund firms appear happier to run recent winners in the fixed income space. The government bond rally in evidence for much of this year has convinced more to join in over the summer. No fund firm could convince itself to turn positive on sovereign debt at the start of Q3. This time around, 15 per cent are on board.

Investment grade is also looked upon more favourably than before, as is emerging market debt - one of the clear favourites of the year.  High yield, on the other hand, has fewer supporters.

With hefty returns already made this year, many might simply want to protect gains for the final months of the year. But if markets do take a turn, it's the latest calls on recent winners that will decide allocators' fortunes.

A fluid situation

It’s felt at times that liquidity and Brexit are the only two topics of relevance to fund selectors in 2019. Inevitably, scenarios that manage to combine both issues have been given a wider than usual berth this year.

James Burns, co-head of the Smith & Williamson managed portfolio service, is among those to have been treading carefully. He sums up:

We [didn’t] want to own anything where liquidity could be an issue, so we have sold some of our exposure to UK smaller companies.

To be more specific, Smith & Williamson sold down its exposure to Miton UK Multi-Cap Income last month, reinvesting in what it sees as more liquid names: Man GLG Undervalued Assets and RWC Enhanced Income.

Since then, the prospect of any kind of Brexit deal at all has been enough to spark a rally. The departure deadline, meanwhile, continues to prove more flexible than its greatest advocates have insisted. 

As we discussed last week, the reduced risk of a no-deal departure will be making some look again at UK assets, regardless of the next steps for politicians. But liquidity’s place at the forefront of current fund selection conversations means many wealth firms will be continuing to keep a wary eye on areas of potential weakness.

One solution already being favoured by some investors is to look at closed-ended UK small-cap portfolios. Broker Stifel noted last month that many such trusts have decent weightings to the FTSE 250 as well as smaller companies - giving them access to more of the domestic stocks that have been rallying hard of late.

Discounts on these portfolios have been narrowing significantly in recent weeks, as you’d expect - from 10 per cent to just 3 per cent in the case of Mercantile IT. Interested buyers will be pondering whether those small discounts could become small premiums before too long.

Drying up

Quilter’s third-quarter results this morning have attracted attention for the scale of the outflows the firm has suffered due to departing investment managers. Losing staff - and clients - in this way will always be a blow in a competitive market. But it’s the other side of the flow equation that has more relevance for the industry as a whole.

As Numis notes, gross inflows that are proving a particular pressure point for wealth managers at the moment. It highlights “subdued investor appetite for investment in new risk assets”, something Quilter has “in common with others in the industry”. 

Inevitably, macro risks and bad headlines about the investment industry don’t make for a good combination. There are still two months of the year to go, but DFMs will already be hoping 2020 brings a fresh start for the sector.

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