Why DFMs' bond options have room to manoeuvre; History repeats itself for UK assets
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. Click here to find out more, and to sign up - we hope to see you there!
Spread out
As equity specialisation goes, so bond specialisation follows? This year, wealth portfolios have been content to stick to the tried and tested favourites: government bonds as diversifiers, strategic bond funds as a catch-all option, and corporate bonds as a way to play the post-March credit bounce.
Could that all change in 2021? There are a more limited set of choices for discretionaries on the fixed income front. One area of growing interest, particularly now the dollar is weakening and optimism is rising over emerging market fortunes, is EM debt.
But other niches may remain relatively untapped. Dedicated high-yield bond funds have never been a default option for discretionary managers. There has been a decent increase in interest this year amid the credit rally – around half of all DFMs now include a dedicated fund somewhere in their model portfolios - but on the whole selectors still prefer investment grade options.
It’s a similar story for their strategic bond fund favourites, most of which still prefer lowly-ranked investment grade securities instead of the highest quality high-yield credits. Others may think the HY opportunity has been and gone: spreads in the US are back to pre-Covid levels, and spreads in Europe are almost there.
Yet some bond managers remain pretty optimistic. TwentyFour says it’s “hard to see many mainstream areas of fixed income outperforming high yield next year”. In Europe, the fund house points to an improving economy, default rates that should again remain subdued, and liquidity support. It notes that spreads are still 117 basis points looser than they were in November 2017.
Axa IM’s Chris Iggo is also relatively positive: he says that a risk-on view of 2021 – a stance shared by most allocators at this point – would suggest spreads could tighten further. There may be life in this market yet.
Home comfort?
Goldman Sachs last week added its voice to those who think the UK is a big opportunity for 2021. Last Tuesday it said both UK shares and the pound were a buy, with firms like housebuilders among those tipped for success. It joins the likes of Morgan Stanley, Citi and UBS in backing the UK for the months ahead.
A week later, and the good news is that the window of opportunity remains very much open for business. The bad news is that’s because analysts’ base case – that the UK will agree a trade deal with the EU - looks marginally less likely, a consideration that’s prompted a few more down days for UK assets.
There are renewed signs of progress on this front today, but it’s unlikely that allocators will be prepared to make their moves just yet. If a deal were to be agreed, however, a repeat of December 2019 may be on the cards.
Back then, analysts were again queuing up to tip the UK - and fund selectors of all stripes did indeed move into domestic assets around the time of the election result. That optimism ultimately proved unwarranted, given the way in which the UK lagged most other indices this year (and in fairness, many allocators did remove those bets almost as quickly as they implemented them).
The bull case for 2021 could again be seen as technical rather than full-throated: UK shares and UK GDP have fallen further than most this year, and so have a greater potential to rebound. Whether or not buyers stay the course this time, or get involved in the first place, remains a big question mark for the coming days and weeks.
Risk off
More than half of Brits believe investing is “too much of a gamble” according to research by Alliance Trust, with loss aversion the main specific worry cited by the 2,000 respondents to a survey conducted on the firm’s behalf.
The study canvassed opinion from a “nationally representative” sample of consumers; wealth managers will recognise that many of these participants will be experiencing particular money worries given the events of the past year.
But that doesn’t mean they share no commonalities with the typical wealth client. Loss aversion remains a fundamental aspect of many clients’ approach to investing, and this year will have been a painful reminder of that for some. The fact that wealth portfolios are back in the black for 2020 is so crucial: it is much easier to accept a year of negligible returns than one in which money was lost. The industry will hope that better times lie ahead once again in 2021.
