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Long/short managers set off down new paths; The end of quality income investing

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Longer days

Short selling – and short covering – inevitably returns to the forefront of investors’ thoughts at times of panic.

The current crisis has again seen some regulators ban shorting, and commentators wonder about the impact that closing out positions might have on asset prices. For DFMs, the most relevant aspect of the debate is how exactly the go-anywhere equity managers on their buylists are reacting to events.

Long/short funds have generally performed pretty well over the past two months. The most notable blow-up among discretionaries’ favourite funds in the asset class – Polar Capital UK Absolute Equity – has involved mitigating circumstances. Otherwise, performance has generally been stable enough.

What of the future? Our latest quarterly analysis of long/short strategies’ shifts indicates most now see more opportunities on the long rather than the short side.

Just five of the below group of DFM favourites reduced their net exposure over the first three months of 2020 – though admittedly, this group did move pretty forcefully in that direction. Among them is Kames UK Absolute Return, which has replaced Jupiter Absolute Return as the only outright net short portfolio as of March 31.

The rest have gradually started to increase the share of portfolios occupied by their long book. But the most telling statistics of all is perhaps one not shown on the chart.

With the exception of Majedie Tortoise, for which data is only available up to February 28, every single fund in our analysis cut back on gross exposure in Q1. One, Smith & Williamson Enterprise, is now running a much more subdued portfolio than at the start of the year. Moves like this emphasise that caution is the watchword for such strategies, even as many start to tilt in favour of long positions.

Up in the air

Opportunities certainly aren’t abounding in the equity income space right now. Last week we reported that many DFMs are now turning to credit as an alternative to diminishing dividends.

Equity income managers themselves are rather more constrained – though it’s worth noting these funds only need hold 80 per cent of their assets in equities. Richard Woolnough’s Optimal Income has bought shares in the past – could equity income funds go the other way this year?

The nature of their investors, and those investors’ risk profiles, might suggest otherwise. But one way or another, equity income managers may well continue to move up the risk scale. For an example of how little “quality” income is left, consider the fate of SocGen’s global screen. The bank’s quality income index usually holds at least 75 stocks from around the globe that yield 4 per cent or more. But it said on Friday that the number of eligible shares “is now so limited as to make the strategy unworkable”. Just 26 companies pass muster as it stands.

A focus on risk remains the most important aspect of income managers’ job at the moment. SocGen notes life was already becoming harder for quality income managers in 2019, given the way quality companies’ dividend yields were dropping as a result of their shares being bid up.

That led some income managers to more cyclical sectors, the outcome being that equity income strategies’ defensiveness was called into question when markets took a turn for the worse this year. If that trend persists, clients’ capital, as well as their income, will start coming under more concerted pressure. The question for dividend strategies is how much further they can push this state of affairs.

Staying put

One piece of relative good news for income hunters this morning came in the shape of BP’s confirmation that it would pay a Q1 dividend. Updates later this week from Shell and GlaxoSmithKline should show a similar degree of stability, at least temporarily.

Winterflood analysts say the trio's maintenance of their dividends should help take the pressure off UK income trusts for the time being. Yet as BP’s muted 0.2 per cent rise today suggests, this particular payout was never particularly in question - either that, or investors are more concerned about the ongoing demand collapse.

Similar news later this week may give income managers some breathing space, but the crunch time will arrive later this year when other payouts have evaporated. The fate of these three big players alone won’t be enough to save managers from the impact of decisions taken elsewhere.

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