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Sized up

This week has brought more evidence that every investor is chasing the same assets. The crowding in tech stocks has reached fresh heights this year - and it’s both hedge funds and retail investors who are huddling together.

In hedgies’ case, this might be because their desire for conviction bets is leading them to focus on fewer long positions than they once did. That’s an impulse that will be familiar to other investors, too. Fund and wealth managers alike have tended to favour concentrated portfolios in recent years. In theory, at least.

This group, who largely remain one step removed from direct investing, are conscious there are limits to how concentrated they can get.

Include just a handful of funds in a model portfolio and, rather than praising the courage of your convictions, adviser clients may ask just what exactly they’re paying for. So the typical model still has more than 20 different positions - though it’s easier to scale back holdings when running passive-only propositions.

We’ve reported in recent months that certain discretionaries have also been condensing active portfolios to ensure there’s no long tail of so-so positions. But there’s no indication this is a definitive trend: aggregate data from our own databases shows the average number of holdings has actually crept up over the past year, from 26 to 27 underlying funds. 

As the chart below shows, a third of DFMs have made rather radical changes to the shape of their MPS over that period. Yet that group is split between those expanding their range of options and those reducing holdings. And the bulk of the industry has left been content to leave things pretty much untouched.

Silver lining

Yesterday’s sharp moves in bonds and equities made one equation a little more compelling. As Bespoke Investment notes, the gap between the S&P 500 dividend yield and the 10-year Treasury yield has reached its highest level since September 2016.

The gap between that dividend yield - now at a still-not-exactly-superlative 1.94 per cent - and 30-year Treasury yields, meanwhile, has risen to the highest level in more than a decade. That’s one of the rare instances over this period in which shares are paying out more than the long bond. All in all, this might provide a measure of support for equities.

Yesterday’s price action was also reassuring, if it’s possible to describe a steep fall in equity markets as such, because bonds and equities moved inversely to one another. As is well known, recent weeks have seen both the S&P 500 and Treasury prices move higher.

Despite that, Bloomberg noted on Friday that the correlation between equities and bond yields was at its highest level in almost a decade - i.e. there’s still a direct relationship between equities rising and bond prices selling off.

The newswire suggests that’s because moves in the two assets have proven asymmetrical: when equities rise, yields move slightly higher. When shares occasionally fall, bond yields fall much further. That means the correlation has held fast, even if weekly summaries show both stocks and bonds moving higher. It also indicates, once again, that 60/40 portfolios are still looking ok for now.

Floating away

For all the concern about interest rates (eventually) moving higher, floating rate notes haven’t found particular favour with fund buyers in recent years. At the time of its launch, M&G’s floating rate high-yield strategy was presumed to be the first of many such products. That didn’t happen, and while M&G’s offering has had a degree of success with selectors, few others can say the same.

Clearly that’s in part because regular bond funds have continued to perform well. But there’s another headwind floating over the horizon, too. Cerulli points out that the 2021 discontinuation of Libor - still used by many floating rate note issuers - will create a risk for bondholders. 

And the consultancy’s alternative suggestion will look pretty familiar to DFMs. It says strategic bond funds make sense as a substitute. On this particular front, discretionaries will rightly think they’re ahead of the game.