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Asset Allocator

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Equity portfolios face up to new concentration risks; UK fund favourites hit the comeback trail

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Elephant in the room

At this point in 2020, allocators will have heard plenty of stats emphasising that big US tech has accounted for the lion’s share of US equity performance. The concentration of returns in the US is well known, and the strength of the Faangs has indisputably helped prop up risk appetite over recent months.

But there’s also evidence that this trend isn’t just confined to the world’s largest equity market. Analysts at SocGen have highlighted that the biggest stocks in other equity regions display similar characteristics: ie that they too are having an outsized impact on their benchmarks’ performance.

One of those benchmarks is the MSCI World – no surprise, given how US shares dominate that index. But SocGen has also found evidence of similar performance in both EM and Asia ex-Japan indices. In EM, for instance, year to date returns of 4 per cent would translate into a loss of around 2 per cent if the 10 largest shares were removed. In Asia ex-Japan, returns of around 8 per cent would be halved.

These may not sound like particularly large discrepancies, but the analysts say they will have an influence on fund manager behaviour, driving more to hold the very largest shares. In turn, that implies “the performance of most funds is potentially driven by momentum rather than their fundamental characteristics”.

That’s a bold claim to make, but one that might give fund selectors pause. Either way, one region where this trend doesn’t hold is Europe: the ten largest stocks have had a negligible contribution to benchmark returns. If the theory holds, that means active managers will have more chance to outperform when they’re a little closer to home.

Middle ground

One other region in which there’s little sign of momentum among the largest stocks is, inevitably, the UK. The FTSE 100 remains a notable laggard among the world’s large-cap indices again this year. And the latest S&P Dow Jones scorecard suggests a fair chunk of active managers have failed to take advantage.

The above comparison of UK funds’ performance was made using S&P’s Broad Market Index rather than the FTSE 100. That makes sense, given UK active managers’ erstwhile habit of overweighting the likes of mid caps rather than the largest stocks.

This is a move that’s tended to pay off in relative performance terms. Even in 2019, when domestic risks were arguably at their peak, a Q4 rally helped mid-caps end the year comfortably ahead of both the FTSE 100 and the small-cap index.

This year, it’s been a little different. Over the first nine months of the year, the 250 index did about as badly as its larger equivalent – underperforming at the height of the crisis, outperforming in the subsequent rally, but doing little of note over the summer.

More recently, there are signs that mid-caps are starting to excel again. The index has shot higher over the past couple of weeks, which might indicate some long-awaited bargain hunting is finally taking place.

It’s no coincidence the move over the past fortnight has come alongside a rise in sterling: the index’s exposure to the waxing and waning of Brexit risks has long since been established. Of course, economic worries aren't limited to Brexit nowadays – yet the prospect of renewed business closures hasn’t knocked the benchmark back in recent days. So allocators might be keeping a close eye on this trend. Against the odds, one of the mainstays of UK equity investing is attempting to mount something of a comeback.

A minor renaissance

There was a time when funds of investment trusts were pretty popular, among private investors in particular. That period has long since passed, though the vehicle has enjoyed some renewed interest from wealth managers lately. Think in particular of the open-ended funds investing in a variety of infrastructure income plays.

That’s a structure that’s appealed to more than one DFM as a way of adding infrastructure exposure to a model portfolio - though questions over liquidity will always linger in the background.

And there are other variants still delivering the goods, too. The unheralded FTSE Equity Investment Instruments Index has now outperformed the All-Share for 13 consecutive months, according to Winterflood. This performance is partly a factor of where the benchmark is concentrated: its weightings to tech and infrastructure trusts have been of particular benefit. But there are also smaller positions in diversifiers to take into account. It’s not quite the equivalent of a multi-asset fund, but as a way of providing lower-risk equity exposure, it offers something a little different. Or at least it would if there were a readily accessible tracker product available.

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