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Asset Allocator

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Searching for spillovers in the oil plunge aftermath; DFMs capitalise on bond dislocation

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Yesterday we said the oil industry couldn’t afford too many more days like Monday. As the afternoon and evening progressed, it became apparent that many might not survive the consequences of those 24 hours alone.

The story of WTI prices’ historic move into negative territory isn’t solely a technical tale of short-term storage problems. Today’s slump in June contracts, and the accompanying sell-off for Brent crude, show the problems are more widespread, if not quite as apocalyptic as price activity overnight suggested.

For wealth managers who have long since abandoned the commodity complex – oil major exposure in equity income funds aside – it’s necessary to zoom out further still. The repercussions for portfolio managers may come in other areas.

Inevitably, those looking at second-order effects have pointed to ETFs as particular points of stress. The need to roll exposures when contracts expire could set up such trackers for long periods of pain. Some market participants think the CME will effectively have to intervene to prevent losses from spiralling.

That said, there’s little sign yet of the spillover effects seen last month when bond markets appeared on the verge of suffering their own existential crisis. Those strains seemingly prompted investors to liquidate all kinds of holdings in a dash for cash.

Oil ETFs aren't as fundamental to market plumbing as fixed income positions. Price activity across major asset classes today isn’t particularly pleasant. But it looks more like another sombre acknowledgement of the deflationary pressures facing the global economy than a suggestion that negative oil prices have changed everything for investors

Bargain hunt

Given all that’s going on in markets – and in the world at large - it’s understandable that wealth managers’ second-quarter outlooks are relatively downbeat. Performance figures have improved over the past three weeks, but few are predicting the worst is over for equity markets.

Still, the speed and scope of the drawdowns seen last month have inevitably thrown up some opportunities for DFMs. And our asset allocation database indicates it’s corporate bond funds, rather than equities, that have proven most attractive in recent weeks.

Earlier this month we noted commentators’ observation that corporate bond markets bottomed three months earlier than equities during the financial crisis. Many discretionaries seem to agree, judging by the allocation shifts seen in March.

Whether it be moving from strategic bonds to dedicated corporate bond strategies, or selling government bond exposure to buy into the likes of Axa US Short Duration High Yield, wealth managers viewed the dislocation in credit markets as an opportunity too good to refuse – not least because the Federal Reserve itself is now lining up alongside them to buy bonds like these. And now that dividends are in doubt, some have even found junk bonds to be a suitable replacement for a portion of their equity income exposures.

One obvious counter-argument to all these actions can be found higher up this newsletter: the oil price slump will have a particular impact on high-yield debt, given the energy sector’s outsized representation in sector benchmarks. So DFMs will again be relying on active managers’ security selection process to ensure they can reap the rewards of the rebound without falling victim to the latest sell-off.

State of suspense

Asked to estimate how many funds across Europe suspended dealing last month, few would pick the right number: 76, according to Fitch Ratings. That elevated figure largely reflects the impact of more than 50 suspensions in Denmark, as well as 15 property funds in the UK and a few other portfolios dotted around the continent.

The ratings agency says the series of gatings in Denmark and Scandinavia, centring on credit market vehicles, may have been due to “higher disclosure standards for fund managers in that region”.

Whether that’s good or bad news for fund industries in the UK and elsewhere depends on your point of view. Lower levels of transparency in some quarters are either masking the true extent of the liquidity problem, or merely allowed managers to get through a brief market dislocation without undue alarm. Given the reputational damage caused by fund suspensions in 2019, most UK wealth managers will probably come down on the side of the latter argument.

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