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Asset Allocator

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How property problems relate to buy-list risk; Good news starts to bug allocators

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When we looked at the concentration of DFMs’ equity fund choices last week, a strength-in-numbers approach was apparent in a number of areas. Today, we focus on bond and property funds - and there’s plenty of evidence of clustering here, too.

Let’s temporarily dodge the elephant in the room by starting with the bond funds. Discretionaries are typically much happier to outsource fixed income allocation calls than they are with equities - meaning strategic bond funds are pretty popular.

And, as the chart below shows, the sector is relatively crowded. The average strat bond fund is held by 2.7 wealth managers - an industry high matched only by the average UK equity strategy.

It’s a similar story for corporate bond funds: these funds may not look too different to one another on the surface, but there’s no doubt that wealth firms are bunching around a relatively select few.

The other two fixed income sectors analysed - high yield and emerging market debt - show pretty low levels of concentration. For high yield, that’s largely because DFMs have limited interest in the sector. Appetite for EMD is higher, but so too is the pool of options from which selectors pick.

But it’s property that’s of most interest to fund buyers this month. As it happens, concentration risk isn’t particularly high by this metric. The typical strategy is held by 1.8 wealth management firms, a figure firmly in the middle of the sector ranges.

More importantly, the funds where clustering is most evident are typically closed-ended in nature. Across the physical property and infrastructure sectors as a whole, almost 80 per cent of DFMs’ holdings are now in investment trusts, funds of funds, or open-ended strategies that offset physical property with a proportion of real estate equities. Discretionaries have long since made their minds up on the structures now hitting the headlines again.

Full steam ahead

For allocators pondering how to position for 2020, even unalloyed economic positives are a problem. Take Friday’s impressive US jobs report, which showed the economy added 266,000 jobs in November - far higher than the forecast 180,000.

Add to this some positive revisions for previous months and better-than-expected wage growth, and the figures have dampened down recession talk for now.

The market reaction was similarly welcoming: the S&P rose 1 per cent and Treasury yields moved higher. In contrast to 2018, investors now believe plenty more positive economic data is required before the Fed even considers hiking rates again.

In short, the change of tack at the central bank creates room for good news to be good news again - rather than making investors fret that each positive piece of news will mean policy will be tightened.

For those with medium to long-term views, however, good news is still problematic. If there’s little proof that the US economy is slowing down, what does that mean for the consensus take that investors should rotate into other equity regions next year? How will this shift affect the odds of a sustained style rotation? And to what extent do “late cycle” phenomena really exist in this, the lengthiest and least representative economic cycle in modern history?

There weren’t easy answers to these questions last week, let alone now. From UK wealth managers’ perspective, the answer thus far has been to stick with their knitting and maintain US equity positions. And as the issues grow knottier, the same strategy looks odds-on to continue into the start of next year.

Contagion equation

News today that the FCA is investigating big funds that have invested in Woodford Equity Income in a bid to limit contagion risk. From wealth managers’ perspective, the assumption has to be that this is a probe that’s only just come to light, rather than one that’s belatedly begun. 

Either way, it’s a sensible move, and one that might be repeated with multi-asset portfolios holding property funds, were the gatings of the latter to accelerate in the coming weeks.

But it’s worth reiterating that the direct knock-on effect of fund suspensions is relatively limited. Firstly, there are few sizeable portfolios that hold material amounts of WEI. Second, even those that do will tend to have no more than 5-10 per cent in a single portfolio. And the property fund experience of 2016 showed that diversified strategies can easily account for a serious slump in one of their holdings. It may hurt relative performance, but it doesn’t tend to spark worrying levels of outflows.

Even those with the highest exposure to Woodford - Hargreaves’ multi-manager funds - have seemingly been able to manage redemptions easily enough, and are now seeing the rate of withdrawals fall. Reputational risk, rather than the domino effect, remains by far the biggest problem to arise from the summer suspension saga.

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