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Asset Allocator

from Asset Allocator

Great rotation awaits for risk-conscious fund buyers; Portfolios' regional rebalancing puzzle

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Credit due

Bond funds have enjoyed quite a run since bouncing off their lows in the first quarter. Wealth managers were among those to spy an early opportunity, and buying continued for much of Q2. In the UK, both corporate bond and global bond funds enjoyed a record month of flows in May.

But while spreads continue to compress and issuance remains strong, more recent data from across the Atlantic suggests interest in riskier debt is starting to cool: a 13-week winning streak for high-yield funds ended on Friday with the news that investors had pulled $3.4bn from such strategies.

Any analysis of EPFR high-yield flows will show it tends to be a particularly volatile asset class. But there are valid reasons for the latest shift.

Even fixed income managers acknowledge the easy money has now been made. And while low base rates should help put a cap on default rates, the likes of Fidelity think that the stresses about to be placed on the corporate sector will be more significant than the consensus expects.

Others are expecting a rotation for more technical reasons. JPMorgan’s flows and liquidity team suggests US investors – like UK DFMs – have been drawing down money market positions since the start of last month, with bond funds the main beneficiary. They expect older US retail investors, in particular, to switch these purchases to equity funds as the year progresses, particularly as equity allocations remain pretty low compared with recent years. It may well be that wealth managers on these shores do something similar in the months ahead.

Global ties

Some investors are happy to jump straight in and give equities another lift ASAP. In the UK, talk of a stamp duty cut has helped housebuilders in particular this morning. That followed the sentiment boost seen overnight, as China’s Shanghai Composite closed at a five-year high.

Retail investors are again in the spotlight in this regard. After much speculation over whether Robinhood traders have helped drive the US equity rally, it’s now Chinese buyers’ turn. A front-page editorial in a state-run paper has seemingly prompted Chinese retail investors to turn more bullish. More reassuring is Friday’s PMI data, which suggests a recovery of some kind is still underway, and the fact that recent talk of a renewed lockdown hasn’t yet proven too serious.

As a result, China-focused European equities are among today’s big winners. That will help add to some investors’ belief that the time’s right for a rotation away from the US and into Europe. But as the WSJ notes, Euro Stoxx companies derive more revenue from the US than they do from France and Germany combined.

Fund selectors may view this as a reassuring example of such firms’ global presence. But the paper’s other warning is more likely to resonate: European shares are closely tied to global rather than regional economic fortunes.

That means their future success is pretty dependent on the fate of the US economy and stock market. The same, needless to say, goes for emerging markets. And that’s one reason why allocators are still a little wary of diversifying away from US stocks.

Small relief

Rishi Sunak’s summer statement this Wednesday looks like it’ll shun tax and spend policies in favour of just spending. Most mooted measures – from stamp duty and VAT cuts to funding for trainees and emergency rescue packages – will put a dent in the Treasury’s coffers. That’s appropriate enough given the scale of economic problems brought about by Covid-19.

But revenue-raising activities will also be on the chancellor’s mind. So it’s no surprise that the usual pensions tax relief rumour mill has begun turning again. For once, the consensus is that action is unlikely this week. That said, when even the likes of the ABI start arguing for a flat rate of relief, it’s clear that such talk isn’t going to vanish any time soon. And the implications for wealth managers’ own coffers might soon be taken more seriously, too.

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