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Wealth portfolios withstand the market rotation; Buyers on the lookout for unassailable hedges

A quick announcement: Asset Allocator will be holding a webinar for wealth managers, asking whether DFMs' ESG allocations are fit for purpose, on December 9.

To find out more and to sign up, click here.

Still on top

How well prepared were DFM portfolios for the current dash to trash? From an asset allocation perspective, it’s a question that has as much to do size and location as it does with investment styles.

Yesterday we highlighted the fact that even the value-investing holdouts had called time on such positions earlier this year.

At the same time, latest figures from our asset allocation database show that discretionaries continued to cut UK equity holdings in September and October. By contrast, US positions continued to creep up – albeit at a slower rate than in previous months.

But this emphasis won’t have precluded DFMs from taking advantage of the current rally. The UK was flagged by some as a particular beneficiary of vaccine-led market moves. So far, however, those benefits are still being spread relatively thinly: while the FTSE 100 has comfortably outperformed the MSCI World and the S&P 500 since November 9, it’s a different story when small caps are considered.

We already know that many wealth firms have been moving down the cap spectrum when it comes to their North American equity positions. And that’s a decision that’s continued to pay off this month. In local currency terms, the Russell 2000 has outperformed UK small cap indices by a couple of percentage points since the first ‘Vaccine Monday’. The gap is smaller in sterling terms, but it's still there.

The ultimate winners over this short timeframe remain the value benchmarks: the FTSE 350 value factor is up almost 10 per cent over the period. But US small caps’ own surge means buyers who’ve continued to disregard the UK in favour of the US won’t necessarily have lost out during the current rotation.

Nothing new

One other shift observable in our assessment of DFMs’ latest allocation changes is a lower reliance on cash. While credit and equity weightings have been rebuilt this year, many wealth portfolios have continued to hold higher-than-average cash positions throughout the rally. That started to change around the turn of the current quarter.

There were two beneficiaries of this move: regional equity positions and alternative assets. When it comes to the latter, a small handful of buyers have started adding to their absolute return positions again. There’s also been a renewed interest in real assets – which nowadays tends to mean infrastructure and alternative income plays rather than commercial property.

The problem for those running model portfolios is that they arguably have little other diversification tools left in their arsenal.

As a case in point: analysts at Goldman Sachs took a look at diversification options for 2021 earlier this month, and their conclusions were rather meagre. The bank’s 10 market themes for next year include the search for “new (and old) safe havens, hedges and diversifiers”, but adds there are “no easy answers”.

Accordingly, its solutions look rather familiar. Gold is dismissed for having an increasingly positive correlation with equities, while the suggested use of FX crosses isn’t the kind of risk that discretionaries tend to favour in client portfolios.

Replacing equity risk via longer-dated calls, selling puts, or by substituting dividend swaps are other options put forward. Ultimately, however, Goldman suggests bond markets might offer better options over time as yields start to tick higher. It concludes: “it may be that if the best ‘old hedges’ reprice a little they will be the best ‘new hedges’ too”.

Advice on the up

Doomy views over the state of the UK economy are, unsurprisingly, easy to find nowadays. Yet market performance this year has again helped mask a number of underlying issues for asset and wealth managers. In the advice sector, things are arguably even more positive.

Figures from the Lang Cat show the majority of the 550+ advisers it surveyed last month reported their turnover would be up or flat for 2020. That’s an impressive achievement given the sector’s instant transition from face-to-face to remote contact earlier this year.

There are potential issues – as there are elsewhere in the retail investment sector – over new client acquisition. But for those advisers who feel they’re already at capacity, or who haven proven adept at overcoming this challenge, the future still looks pretty bright despite their regulatory bugbears.

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