Asset AllocatorOct 30 2019

A new threat to wealth firms' UK income picks; Discretionaries ignore discount options

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Welcome to Asset Allocator, FT Specialist's newsletter for wealth managers, fund selectors and DFMs.

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Firmer ground

A snap election means all bets are off, once again, for UK assets. That’s the view of analysts who cite, among other risks, a renewed chance of no deal at the end of January.

In truth, the pound remains materially higher than it was four weeks ago in large part because the UK government now has a deal to defend. It's unlikely to advocate for a no-deal departure from this point on.

A Conservative majority or minority government is almost certain to fall in behind that deal come January. Any other election result would likely mean a referendum - and the EU, for all the grumbling from France about repeated extensions, is unlikely to insist on a cliff-edge exit as an alternative. So there remains a floor under sterling for now.

As we’ve discussed in recent weeks, the mere existence of the prime minister’s deal has made more investors take note of UK valuations, sparking an upturn for UK equities.

And for all the concern about UK equity income fund outflows, and the bond-proxy holdings found within many such portfolios, UK income funds have outstripped growth strategies over recent weeks and months. Dividend strategies have had a fantastic decade, but that doesn't mean valuation opportunities aren't apparent there, too.

But rising confidence in the domestic market, were it to continue, could come at a cost for some DFMs’ preferred income portfolios. A surge in risk assets would have implications for call option writing funds, whose strategies require them to sacrifice some upside as part of their bid to boost yields.

In the short-term, the election will put its own cap on potential upsides for UK assets. And growing volatility elsewhere means covered call options will remain a decent bet in most parts of the world. But come 2020 those who are growing more interested in UK equities may need to consider exactly how their UK income allocations stack up. 

Risk premium

UK equity investment trust share prices are increasingly reflecting this increased optimism: discounts are starting to close as buyers return. Wealth managers taking advantage of this trend will find themselves standing out from their peers: the vast majority of fund selectors are still holding on to past winners.

Our analysis of the equity investment trusts held by DFM portfolios, as per our fund selection database, shows that few discretionaries are taking the plunge on unloved positions.

Of those trusts held across the various UK, US, Japanese and Global equity sectors, more than 90 per cent are currently trading at a higher premium (or lower discount) than their sector averages. 

The implication - that wealth firms are less likely to back or stick with underperformers in the trust space - stands in contrast to their open-ended fund picks, which do often lag either a peer group or benchmark.

Wealth firms are also more likely to plump for popular choices when it comes to multi-asset offerings. Stalwarts of that sector like RIT Capital and the Personal Assets trust are both trading on premiums to NAV and to peers, and both have found favour with selectors. So running winners is not just about being gung-ho.

There are a handful of areas where wealth managers are more interested in out-of-favour names. A small number of EM or Asian equity trusts trading on sizeable discounts, like Utilico Emerging Markets or Edinburgh Dragon IT, can still be found in discretionary portfolios. But this limited sample is about the extent of DFMs’ contrarian positioning when it comes to the investment trust world.

Much at stake

Schroders’ sale of its sizeable stake in RWC marks the end of a chapter for one of the more notable fund management success stories of the past decade. The FTSE 100 firm’s reasons for selling are obvious: assets at RWC have risen from less than £1bn to around £14bn since the stake was acquired in 2010. Terms of its sale have not been disclosed, but the gain is surely sizeable.

As we’ve written before, RWC is among those firms who have shown that, in the UK at least, the “squeezed middle” doesn’t really exist for fund managers: selectors actively prefer businesses that have scale yet are free from corporate bloat or other pressures inherent to a large company.

It is the next steps for firms of this size that can prove the toughest: at a certain level, the obligation to grow further starts to impinge on fund buyers’ perception of the business. RWC is not at that point as it stands; wealth managers will hope it remains business as usual at the asset manager for a good while yet.