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Asset Allocator

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Where DFMs are turning for a new era of UK income; Weightings game highlights equity risks

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The wheel turns

There’s some light at the end of the tunnel for UK equity income investors. As insurers and others start to restore payouts, BP’s August 4 decision to cut its dividend may ultimately prove to be a symbolic turning point for UK plc.

Allocators haven’t made their way out of the darkness just yet: UK payouts are still tipped to fall up to 42 per cent this year. Normality, needless to say, is a long way off. And even wealth managers trying their best to ride out the slump have taken the opportunity to rethink their positions.

Our fund selection database shows that almost 40 per cent of DFMs have either added a new UK equity income strategy to their model portfolio ranges this year, or sold out of an existing holding.

For a sector with which most buyers are deeply familiar, and where the pool of available choices has remained largely the same for a decade or more, that’s a significant level of turnover. But while those making changes are reacting to a sudden change in circumstances, past performance is still having a significant bearing on their actions.

Strategies that have been disposed of are typically those that lagged peers last year as well as this, like Majedie UK Income. Those being bought unsurprisingly include more defensive portfolios like Troy Trojan Income. The most popular addition to portfolios in 2020 has been Franklin UK Equity Income – which held up almost as well during the sell-off. But as of last month, its largest positions still included the likes of BP and Shell: little sign here that fund selectors are trying to reinvent the wheel. And nor does our database provide much evidence yet of selectors looking further afield. Global payouts are forecast to fall much less than in the UK, but global income funds’ are facing problems of their own at the moment.

Easterly wind

Markets remain relatively subdued by recent standards, and US dollar weakness is giving a fillip to emerging markets. Wealth firms, however, have largely been content to let those particular sleeping dogs lie.

EM and Asian exposures remain a relatively small part of most portfolios, and fund selectors have been focusing on whether their bigger positions – like equity income, for one – are fit for purpose.

But macroeconomic factors aside, there are other EM issues that are worth due consideration from buyers. We’ve discussed in the past how many DFMs are now favouring dedicated Asia ex-Japan funds at the expense of the traditional EM strategies of old. Increasingly, indices themselves are doing something similar. As the FT notes, the MSCI Emerging Markets now has a 78 per cent weighting to Asia, with China/Hong Kong, Taiwan and South Korea alone accounting for almost two thirds of the benchmark.

Wealth managers’ favourite EM picks tell a similar story. The likes of Hermes and Fidelity Emerging Markets, as well as the increasingly popular Baillie Gifford EM Growth, also hold 60 per cent plus in these three areas, rising to more than 70 per cent once India is included.

That leaves just one popular pick that shies away from Asia, relatively speaking. RWC’s strategy is underweight every country in Asia as of this summer. Whether that differentiation is the kind fund buyers are looking for is another question.

Going for gold

Mohamed El-Erian’s comments on gold have a ring of truth to them for wealth firms. Bullion has increasingly become a part of long-term portfolios, not least because it can offer “something for everyone”.

Acting as a potential hedge against deflation, inflation, US dollar depreciation or general economic collapse – depending on your point of view - means that most buyers will be able to justify adding the precious metal to their holdings. But as the article notes, the same kind of thinking is increasingly also applied to tech stocks and, now that the Federal Reserve backstop is in place – credit.

It’s certainly true that these have been three big drivers of private client portfolios’ recovery since the end of Q1. DFMs won’t be naïve enough to think that using these asset classes in combination has helped them triumph over the market cycle. But they might pause to think about the ultimate consequences of these increasingly insistent preferences.

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