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Asset Allocator

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DFMs' structural shift on equity allocations; Diversifiers wobble as momentum trades reverse

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Off radar

Amid the typical Q2 fund manager merry-go-round, some moves stand out more than others. Gary Greenberg’s decision to step back from day-to-day fund management at Federated Hermes, for instance, will have an impact on the many DFMs who back his strategy. But fund buyers’ EM problems are more existential than fund-specific at the moment.

The Hermes vehicle is wealth firms’ most-selected EM fund, and also tends to be bought in bulk - holders tend to allocate more to the strategy than peers do to rival funds from the likes of RWC and Fidelity, according to our fund selection database. That said, “bulk” tends to mean something slightly different nowadays.

The average moderate model portfolio held just 3.3 per cent in EM equity funds as of April 30. Not so surprising, given most allocators’ risk appetite remains decidedly mixed.

But the issue increasingly looks more structural than cyclical. We’ve spoken in the past about how Asian equity funds are replacing broader EM allocations in balanced portfolios. Now, in 2020, even clients with an appetite for risk may find their wealth manager has limited their EM exposure.

The average weighting to emerging market funds in wealth firms’ aggressive portfolios currently stands at just over 8 per cent. But that figure is skewed by the odd DFM who still likes to go big on EM at the outer limits of the risk spectrum. The median exposure stands at just 5.1 per cent – a figure not too distinct from the moderate weighting mentioned above. And this isn’t simply a case of discretionaries bulking up on Asian equities. Their aggressive portfolios are nowadays full of US equities, tech and other thematic plays, as well as single-country strategies. The future for the catch-all emerging market fund looks pretty uncertain at the moment.

Danger ahead?

There are some unloved parts of the market that have enjoyed renewed interest over the past month. In the US, the S&P 500 is now more or less flat year-to-date – before dividends are factored in. And virtually every company in the index has shared in the fun of late: not a single stock in the S&P is down over the past 10 weeks.

As that implies, it’s not just about tech and healthcare. Other sectors have been playing catch-up in recent weeks, as investors get on board with the rally and look to pick up some bargains.

But there have been casualties as a result: some of the erstwhile winners have been kicked to the curb to make space for these lesser lights. For evidence, look at the recent performance of US momentum indices. Having navigated March’s market madness with little more than a shrug, returns have slumped dramatically in recent days.

Admittedly, this particular index isn’t your typical benchmark: it’s a long/short basket that tends to see periods of excess volatility. But its doing so at this point, having avoided such pitfalls so far in 2020, is worth pondering further. So too is the fact that Treasury yields started to climb higher in tandem with the momentum sell-off last week.

Treasuries stabilised yesterday as the momentum slump continued, and there are other plausible explanations for bonds’ own sell-off last week: payrolls data being the most obvious. Yet the link between momentum and bond prices has been highlighted before now, and many allocators won’t be dismissing it out of hand just yet.

A new environment

The growing force that is ESG investing made it inevitable that Vanguard would look to add more such strategies to its roster. Today is that day – and the success, or otherwise, of its passive ESG offerings will test the theory that tracker products are fundamentally unsuited to such strategies.

The stakes are pretty high already: some active managers see ESG as a way to future-proof their businesses against the growing tide of passive investing. True, Vanguard’s new products are of the negative-screening variety, a method which has fallen from favour among asset managers as ESG approaches have developed over recent years. But that won’t matter if they end up capturing investors’ attention – and assets – in their droves. It’s an experiment that most of the investment industry will be watching closely.

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