Asset AllocatorNov 26 2019

Wealth managers sceptical of momentum trade reversal; Two-speed bond market hits home

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

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Staying watchful

How are DFMs positioning their portfolios for the final months of the decade? On the face of it, those hoping for a serene end to the year have got their wish so far. But market chatter over the past few weeks has been all about the rotations going on under the surface.

As a result, there were a handful of notable portfolio alterations in October, according to our asset allocation database - though the most apparent had little to do with the value rotation seen in recent weeks.

Instead, it appears to be the pressure on China and the Asia-Pacific region that has started to hold sway. While Asia-Pacific ex-Japan allocations dropped back over the month, weightings to broader emerging market funds rose in October. That means that the average EM position is higher than the amount of cash allocated to Asia funds for the first time in more than a year.

But some old habits die hard. In keeping with most months this year, discretionaries added to their US equity positions despite the growing calls for prudence. The average weighting to US shares within a balanced strategy ticked up from 14 per cent to 15 per cent on the month.

In contrast, wealth managers are yet to be drawn in by the European and Japanese stocks given a lift by investors’ growing interest in value stocks. Only one wealth firm in our database increased their European exposure in October, and just two did likewise for Japan.

Away from equities, the rise in sovereign bond yields seen in October corresponded with a fall in DFMs’ government bond allocations. In contrast, hedge fund and absolute return positions began to move higher again. As we noted yesterday, a year on from a period in which many such diversifiers disappointed, discretionaries are growing more confident in their alternatives’ ability to deliver once again.

Take out the trash

Along with US equities, high-yield bond exposure remains another mainstay of wealth managers’ portfolios. Not in absolute terms - overall weightings remain relatively low, or else typically accounted for by their strategic bond positions - but when it comes to delivering the goods for investors. High-yield strategies have continued to produce healthy returns this year, even at times when sovereign bond prices have been falling. 

It’s not all plain sailing, however: it’s worth pausing to examine the extent of the divergence that’s now emerging in the junk bond market. There are now two distinct groups of issuers, as we highlighted last week: the haves and the have nots. And many of the laggards can be found in the energy sector.

Increasingly, this appears to be a story of quality. Triple-C rated bonds are starting to materially lag the rest of the high-yield market. In the US, credit spreads for this group are now at the widest levels for three years - whereas spreads on BB-rated bonds, ie the highest junk rating, are still close to their tightest-ever levels.

In many ways this trend is reminiscent of the late-cycle activity in the equity market, where the proportion of stocks at 52-week lows is on the rise, and yet indices themselves continue to trend higher. 

But the preference for quality isn’t playing out the same way across the corporate bond market. This isn’t a case of investors demanding the highest-quality debt in every asset class. The much-talked about triple Bs - the lowest rung of investment grade debt - continue to perform well. It’s only the junkiest credit that has seen investors flee of late.

High stakes

Consolidation among DFMs shows no sign of slowing down, but the more interesting developments are taking place elsewhere in the retail investment sector. Providers with deep pockets are increasingly spreading their reach across different parts of the investment chain.

Today brings the news that Franklin Templeton has taken a stake in Embark, the platform and Sipp provider that is itself on the acquisition trail. To get a sense of the cross pollination involved, consider that Franklin Templeton’s stake is being used to fund Embark’s acquisition of Zurich’s adviser platform  - and that the deal comes hot on the heels of three other fund managers taking a combined stake of their own in Embark earlier this year.

Combinations like this are evidence that vertical integration isn’t always going to mean a single provider buying a single distributor. Taking stakes rather than acquiring outright allows fund houses to test the water -  and in the interim will see them accrue financial benefits without scaring off investors worried about product pushing. One way or another, the increasing interconnectedness of the investment world is a trend that looks destined to persist.