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Two steps back

Parts of the developed world may increasingly look like they’re reverting to state of play seen in March, but investment markets have long since moved on. The risk asset recovery has shown little sign of going into reverse this autumn, despite the renewed economic restrictions emerging in Europe and elsewhere.

But while markets continue to rise, not all managers are duty bound to be bullish. So to gauge how sentiment stands, we’ve turned again to DFMs’ favourite long/short portfolios.

Last time we checked in on these strategies, measuring their net exposures as of the end of the first quarter, it was something of a mixed bag. Several cut back on their net exposures in Q1 – but plenty of others did the opposite in the face of the market slump.

As the chart below shows, it’s a similar story this time around, albeit with different strategies leading the way. Majedie and Jupiter have continued along the same path as they did at the start of the year, net exposures having increased further over the past six months. But most other managers in the list have taken the opposite tack, reversing the moves they made in the first quarter.

Again, it’s gross exposures that tell a more consistent story. All but one of these funds cut back on gross exposures in Q1; three quarters subsequently increased those exposures over the next six months. And while most net positions are now roughly in line with where they were at the start of the year, almost all gross exposures remain below the levels seen back then. There’s still some caution to be found among the long/short cohort.

Escalation

How did fund buyers respond to tech shares’ summer surge and September wobble? Latest fund flow estimates from Morningstar suggest the minor sell-off seen early last month didn’t change much thinking on this front. In fact, it was other parts of the market that saw sellers re-emerge.

Of course, the Faangs did quickly shrug off that stumble and continue their upwards trajectory. As a result, selectors seemingly had little cause to reassess their preference for quality in general. Other staples of the current market, like Fundsmith Equity, continued to take in money on the month.

By contrast, some of the biggest redemptions came from areas in which you’d be forgiven for thinking investors had already capitulated. Absolute return was one: more money was pulled from the multi-asset favourites of old. But unloved areas like Europe and Japan also struggled. Some £100m went from the Lightman European value strategy, while stalwarts like Crux European Special Situations and Baillie Gifford Japanese also saw hefty amounts depart their open-ended offerings.

As we’ve seen in the past, some of these assets may simply have moved to segregated mandates, rather than exiting strategies entirely. All the same, it’s striking that recent fund buying trends appear to have accelerated still further in September, rather than indicating an imminent reassessment. 

Not waving, but drowning

One catalyst for change could be a ‘blue wave’ in Washington in a couple of weeks’ time. So far, our assessments of how this plays out have largely been confined to the US market. And the shift to smaller companies is clearly being favoured by many investors at the moment.

But if a Democratic sweep does effectively mark the start of a reflation trade, there’s the possibility this spills out into other geographies. As FT Alphaville notes, UBS analysts believe certain European shares could be beneficiaries.

The lessons of recent months, however, suggest that selectors’ regional preferences are hard to dislodge at the moment. The shift to US small-caps makes sense in that context, but it’ll likely prove harder to find those who materially up European allocations on the back of activity across the Atlantic.