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Asset Allocator

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How DFMs positioned for a new decade; The fear factor haunting currency plays

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Fresh start

How have DFMs positioned portfolios for the start of a new decade? With wealth managers enjoying a quieter conclusion to 2019 than a year before, the boost in risk appetite witnessed elsewhere appears to have seeped into the discretionary space.

The average Balanced portfolio equity allocation rose by more than 4 percentage points over Q4, sitting just shy of 58 per cent. In keeping with recent trends DFMs continued to increase US allocations but also spotted bargains elsewhere. A temporary parting of the Brexit clouds saw the average UK weighting rise by a percentage point, but other value plays also attracted interest. A handful of firms upped their exposure to Europe and Japan.

Like asset managers, wealth firms are now less hot on fixed income, with the average bond allocation sitting 3 percentage points lower. If government bond allocations fell back, so did more income-friendly options: EMD, high yield and strategic bond weightings were all down at the end of the quarter.

But the shift in fixed income allocations owes more to firms executing large about turns elsewhere. When it comes to both investment grade debt and index-linked bonds, the average is down notably after two or three names significantly reined in their allocations.

Beyond the realm of traditional assets, there's further evidence of the alternatives divide we identified last year. The average allocation to hedge fund and absolute return strategies nudged slightly higher in Q4, but the number of wealth firms reducing allocations here was only slightly behind the amount loading up. If the year ahead proves rockier than 2019, it’s dividing lines like this that could sort winners from losers.

Softly, softly

When it finally ends, one reign only gives way to another. And so, if a widely mooted US dollar weakening does come to pass, it spells the ascendancy of a host of other currencies and assets.

Step forward, EMD. One of the standouts of the bond universe in 2019, in part as a last bastion of attractive yields, it’s once again tipped for good things in the year ahead. And while any dollar weakness will add another tailwind to local currency debt in the region, DFMs are yet to take a leap of faith.

Firstly, many wealth firms continue to shun the asset class, with a select group tending to take notable positions. And even for those with a stake in the asset class, a more cautious approach still seems the best fit.

In late 2018 we noted a preference for EMD funds with a go-anywhere approach in terms of currency exposure, with the top strategies erring on the side of caution. Fast forward to 2020 and it’s a dynamic that has stuck: the number of DFM picks in the EMD space has risen, but the most popular name, M&G Emerging Markets Bond, represents an even greater share of selections than before. And the M&G team continues to heavily favour hard currency debt.

Local currency funds have not flooded the list, either. The number of funds with a soft currency bias has risen marginally – but their share of the overall selections has actually fallen. Even with a stellar 2019 behind them, local currency plays may be a risk too far for some.

Quant and quality

Viewed as a talking shop in many quarters, the World Economic Forum’s yearly gathering may nevertheless deliver occasional nuggets for investment professionals. And so to Davos for one insight on ESG.

As we’ve discussed, it’s one area identified as a place where active managers could continue to grow, and even redeem themselves among consumers.

That’s not to say that passives don’t have a role here: while the arguments about conventional trackers and weak ESG credentials are well rehearsed, DFMs in our database do tend to hold some passive and smart beta products within the likes of ethical and sustainable models.

But as the FT’s Moral Money reports, some portfolios may struggle to move in line with these trends. UBS president Suni Harford warns that a reliance on mainly backward-looking data means quant funds may struggle, at least, to actively engage with the relevant issues.

For DFMs it may give pause for thought – and fuel further scrutiny of systematic investors who have struggled in the past.

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