Welcome to Asset Allocator, FT Specialist's newsletter for wealth managers, fund selectors and DFMs.
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At this point, allocators’ decision to load up on credit in the aftermath of the Fed’s backstop efforts is well known. Wealth managers’ own moves on this front were first apparent several months ago; bond fund flows since then showed they were far from alone in seeing opportunities in the fixed income market.
But what of bond fund managers’ own preferences? DFMs have been buying up corporate bond and high-yield debt funds – often at the expense of strategic bond strategies. The latter, of course, have the ability to buy government bonds as well as credit and everything in between. And while some allocators have seen the Fed’s actions as an excuse to load up on risk, our analysis suggests there’s been little in the way of a dash for trash by managers.
As the chart below shows, DFMs’ favourite strategic bond funds have actually cut back on their holdings of BB or B rated debt quite markedly since the start of the year. Much of this shift came during the crisis’ nadir – but by the same token, the subsequent rally hasn’t yet convinced all managers to move back in. And while CCC holdings have crept up, they remain at very low absolute levels.
The biggest difference, however, is clearly in BBB bonds – the lowest rank of investment grade debt. Covid-19 has prompted plenty more fallen angels to emerge, but the evidence suggests strat bond managers are more relaxed than ever about the risk/reward equation for triple-B bonds. The average weighting here has risen by six percentage points since the start of the year, and now accounts for more than a third of the typical portfolio. UK managers’ preference for lower-ranked IG debt has never been as apparent as it is at the moment.
Many allocators, be they bond managers or DFMs, will think the easy gains of Q2 have now been and gone. There’s evidence that equity investors are starting to think something similar: the S&P 500’s brief move into positive territory for the year yesterday was enough to spark a quick reversal in fortunes.
That’s spilled over into European trading this morning, and there are even signs of nervousness when it comes to the all-mighty tech sector. The widely-followed TQQQ ETF – a leveraged play on the Nasdaq – saw its largest net outflow on record last week, according to Bloomberg data.
With a dismal earnings season beginning this week, such actions will make sense to many allocators. The problem is that those who are most wary will have been sitting on cash for several months now. Our own database indicates the average balanced wealth portfolio still has 6.5 per cent in cash – and, as of last month, a quarter still held double digit cash balances.
The question of what to do next will be particularly tough to answer for this cautious cohort. Those who’re holding cash instead of defensive or alts allocations will be happy enough to stay the course. But those who hiked cash as a tactical play when markets slumped in March will now be aware that events have overtaken them. Deciding whether to stick or twist is as much a problem for those who are underweight equities as it is for those who have long since bought back in.
Earlier this month we noted that Numis had predicted a clear-out of the investment trust sector, courtesy of the greater scrutiny now being given by boards to their underlying strategies. This week the broker has gone one further, asking whether a wave of consolidation is underway.
Its statistics show that half the investment company universe is now under £200m in size, rendering many uninvestable for wealth managers. Yet consolidation is harder to come by than it may seem: Numis points out that managers rarely propose mergers, and liquid trusts have the option of returning capital at NAV instead.
The onus, then, may be on shareholders to become more active rather than just selling. There is plenty of scope for that – some 78 per cent of trusts launched between 2000 and 2009 are no longer in existence, according to the broker. But that falls to just 23 per cent for the prior decade. Wealth managers will have a part to play in evening up those numbers.