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Asset Allocator

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The bond funds shifting their credit mix; Allocators' surprising contrarian bets

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Dipping a toe

The go-anywhere funds of the equity universe are taking a measured approach to risk. But what about their bond equivalents?

Earlier this year we noted that the credit rush seen across the investment world had merely prompted strategic bond funds to scale back their own appetites somewhat. Instead of hunting out the very riskiest offerings which were rallying on the back of central bank support, these strategies doubled down on their preference for BBB-rated investment grade debt.

That may be the lowest rank of IG credit, but it’s still a far cry from the credit status of those lower down the ladder.

Four months later, things have started to shift just a little. As the chart below shows, there are more signs of an appetite for riskier, higher yielding bonds.

That’s most apparent in the BB portion of the market. The average exposure here has risen from 27 per cent to almost 30 per cent over the summer. When compared with the 35 per cent figure recorded this time last year, however, prudence is still evident.

Unrated debt is another area of note. Exposures here remain very low in absolute terms, but a current average of 4 per cent is the highest for two years and a sign more managers are looking off the beaten track.

Yet on the whole it’s hard to say strat bond funds have sacrificed quality as yields began to fall again this year. BBB weightings have fallen, but this is almost entirely due to Allianz and Janus Henderson having materially cut back on exposures here. Most other managers have preferred to maintain much the same positions. And the likes of Rathbones now hold almost two-thirds of their portfolio in triple-B bonds. It’s still something of a sweet spot for the sector as a whole.

Weight loss

Ask any investment manager for their list of crowded trades and you won’t struggle for a consensus. For many months, ‘long US tech and growth’ has been the standard answer on this front from respondents to BofA’s fund manager survey.

But there are those who differ slightly on this front. Research from UBS, using FactSet data to measure global active managers’ most overweight and underweight positions, throws up some surprising results.

It finds that the top five overweight positions globally, as of this month, are Visa, Adobe, Alibaba, PayPal and Mastercard. The likes of Salesforce, Alphabet and Facebook follow close behind.

No need to ponder the similarity between these stocks – and while the payment processors don’t quite fall into the same category, they have been as much a beneficiary of the rush to US growth shares as anyone else.

A look at the largest underweights, however, might raise a few eyebrows. The top five are Apple, Taiwan Semiconductor, Nestle, Amazon and Tencent.

Of course, this is partly a story of index weightings. The average investor weighting to Apple, at 2.8 per cent, is much higher than for any of the top overweights mentioned above. But it’s still classed as a material underweight due to its 3.9 per cent position in the MSCI AC World benchmark. And it’s a similar story for Amazon, which accounts for 2.4 per cent of the average portfolio. Still, there’s reason to ponder just how many managers are holding these stocks for reasons of benchmark risk (or opportunity cost), rather than active interest.

Lacking lessons

Allocators often say that down days in markets can teach them more than they’d learn from a month of serene progress. But good to luck to anyone attempting to draw conclusions from last night’s activity in the US.

A widespread move lower was again pinned on nerves over the possibility, or otherwise, of a stimulus deal arriving prior to next month’s election. But the likes of airlines and retail stocks had relatively good days, while tech did not.

Similarly, the overall index declines were matched by a slight fall in government bond prices. And the latter move didn’t seem to do much for the financials which tend to react to shifts in Treasury yields. The conclusion - other than the fact there’s no real conclusion at all to draw from this mix – is that it may be a confusing week or two prior to polling day.

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