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Wealth portfolios on red alert as returns seesaw; The death of diversification

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Half full?

Wall Street has just finished its best quarter for more than a decade, and European stocks are starting to attract more attention, too. If only things were always so simple.

Memories of what came before are still uppermost in investors’ minds, not least because the pandemic is far from over. And actively managed portfolios have had their own problems grappling with the transformation of a ferocious downturn into a sizeable rebound.

The average private client portfolio remains in the red year to date, but is now more or less flat on a one-year view, according to Pimfa data. In a difficult 2020, allocators will have at least taken heart from the fact that much of what worked in 2019 has done so again this year.

That may prove of little help when deciding how to position for the coming months, but it has helped with short-term decision making.

Not all existing preferences have continued to prosper, however. The chart below shows how DFMs’ ten favourite funds in the given sectors have fared on a relative basis over the past 12 months.

It’s clear that red warning signs are flashing in a couple of areas – strategic bond favourites have found life tough going, in part because many were light on the government bonds that rallied hard again at the start of this year. As we discussed last week, wealth firms’ core UK picks are still performing well in the main. But plenty of others in the top 10 are struggling. And the US is also a bit of a mixed bag.

On the plus side, DFMs’ preferred plays in Europe and Asia have proven adept at navigating markets. Fund selectors’ preference for high-quality portfolios has helped out in both cases. That should stand them in good stead for an uncertain future, too.

Redrawing the map

As half-year outlooks start to emerge, it’s safe to say gung-ho approaches won’t be top of the recommended list. That said, the coronavirus crisis is prompting some to rip up their old thinking – and to encourage their fellow investors to do the same.

BlackRock’s Investment Institute has taken a rather grandiose view of the current state of play. But its conclusions are clear cut: a “completely new macro framework and major view changes”. For investors, that means “a reassessment of the whole portfolio, not just tweaking at the edges” is required.

Wealth managers tend to be sceptical of such thinking: when it comes to portfolio construction, wholesale changes are uncommon, if not unheard of, in recent years. And some of the strategic shifts recommended by the BII have already been taken on board.

Few DFMs, for example, will need to be told that government bonds won’t prove as effective a diversifier as they did in the past – even if this assumption was confounded again earlier this year. The suggested replacement, of index-linked debt, is already being reintroduced to many model portfolios.

Similarly, the suggestion that sustainability will both drive performance and create “entirely new sources of returns” is well recognised by wealth firms.

But BII’s third strategic view is arguably lower down DFM radars. It predicts a breakdown in globalisation means return dispersion across different regions will increase. That calls into question broader asset classes like emerging markets, and makes specific country and sector-level exposure more important.

In short: “asset class diversification alone is not going to work any more”. With most DFM allocations still drawn along geographic lines, this is one outcome that would have notable consequences for their portfolios.

Acquiring the habit

Global dealmaking dropped to its lowest level in more than a decade in the second quarter, but no one told the asset management industry. The first day of Q3 has seen the completion of Jupiter’s acquisition of Merian – admittedly a purchase agreed in the first quarter -  as well as Schroders taking a majority stake in an Asian real estate manager and Liontrust buying Architas.

So the consolidation bandwagon rumbles on. Those who long predicted such trends will feel vindicated by the recent uptick in activity – and confident that there’s more to come. After all, we’re arguably not yet at the stage where distressed assets come into play. Retail investment firms will hope it doesn’t come to that, given such deals tend to be borne out of falling markets. But troubled times ahead would mean more deals, and more consequences for fund selectors.

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