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Allocators slash time horizons as crossroads near; DFMs' liquidity fears get fresh jolt

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Sea change

Global fund manager data has confirmed what we reported on Monday and last week: risk appetite has become altogether more ravenous since the start of the quarter.

That means a record surge in global growth expectations, the biggest monthly drop in cash levels for three years, and the lowest absolute cash levels for six years. But now, says Bank of America Merrill Lynch, comes the hard work: sustaining the kind of rally seen since October will be tougher than starting it in the first place.

There are a number of second-order effects, too. Some are pretty obvious - the proportion of investors who believe value will outperform growth over the next year has risen from 13 per cent to 35 per cent in just a single month, according to the bank's latest survey. Others are more more noteworthy - more than a third of managers now expect the US dollar to depreciate over the same timeframe. That’s the highest proportion since 2007.

Equity allocations have been reshuffled as a result: it’s now EM rather than US equities that are the consensus overweight. European and Japanese exposures have moved from neutral and underweight, respectively, to overweight. And UK equity sentiment continues to rise, too, albeit from rather lower levels.

And yet, some preferences appear unshakeable. Net tech exposures rose from 23 per cent to 29 per cent in November. Whether that reflects a newfound interest in old tech rather than new tech is not in the survey’s power to answer. 

But progressing from this point may prove difficult. The trade war remains investors’ biggest tail risk, but more than half say that a positive resolution will prompt only a marginal improvement in business sentiment. Those risks remain slanted to the downside.

So while wealth managers will be grateful for the latest surge, adding a nice gloss to what was already a good year for returns, but the question of how to move forward has got thornier. That’s underlined by fund managers’ time horizons: 57 per cent say they’re currently investing on a six-month view, up from 43 per cent in October.

Debating ratings

A new research paper has some alarming findings for fund selectors at a time when liquidity is still worry number one - and though a row has erupted over its accuracy, the implications for buyers are the same either way.

The paper’s authors claim that Morningstar’s reliance on self-reported summaries from fixed income funds has led to a number of classification errors - chiefly because some funds are deliberately misreporting the credit quality of their holdings. The net result, they say, is that many bond funds are more risky than the rating agency indicates.

Morningstar has attempted to refute the findings, saying that much of the difference between self-reported data and publicly available figures lies with how it classified “not rated” securities. The ratings agency uses this designation when it cannot match securities to its own database; it automatically equates to a high-yield bond rating.

By contrast, according to Morningstar, asset managers will typically have more complete information on the credit rating of securities in their portfolios. So the ratings provider’s calculations often produce a lower average credit quality than funds’ own statements.

That means funds aren’t necessarily deliberately misreporting data. But there are other claims made in the paper, such as the suggestion that the biggest discrepancies occur when funds have been underperforming.

For fund selectors now taking an even closer look at what’s going on under the bonnet of their holdings, this kind of finding brings to mind the issue we noted last month. Fund buyers’ attempts to gauge the liquidity of a portfolio, in particular, are dependent on trusting fund providers’ own assertions. DFMs should think more carefully about whether their due diligence processes can stand on their own two feet.

In the mire

Animal spirits may be on the rise again, and sentiment towards UK equities is still improving, but there are plenty of headwinds ahead for the domestic economy.

Inflation rates remain stubbornly below target, and the rate of GDP growth is also heading in the wrong direction. In the short term, these factors will pale in comparison for investors to the election result and the prospect of a Brexit deal passing Parliament. 

Should those two hurdles be cleared at the start of next year, attention may turn rather quickly to economic fundamentals. In this context, the stimulus packages promised by both major parties will be welcomed by investors: there are still plenty of deflationary pressures to be warded off. And with the Bank of England already sounding out the prospect of a rate cut in the event of further economic weakness, escape velocity looks to be far away as it ever did.

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