Wealth firms bed down with not-so-explosive bonds; Diversifers vs premium pricing structures
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Bedding down
Today marks 11 years to the day since Bill Gross famously said gilts were “sitting on a bed of nitroglycerine”. Since then, of course, it’s been prices rather than yields that have exploded: benchmark 10-year gilts yielded around 4 per cent in 2010; today they offer a paltry 0.3 per cent.
So Mr Gross’s call was at least a decade too early, and there’s still little sign of things changing. Last year was another healthy one for UK government bonds, courtesy of pandemic-induced flight to safety.
Needless to say, there are still plenty of allocators who have their doubts over gilts’ future prospects. But the thinking behind this fear has changed: those running portfolios aren’t always concerned about an imminent leap in yields these days. Instead, they worry that ultra-low yields mean bonds won’t be able to outperform so easily at times of market stress.
All that said, most DFMs haven’t given up on gilts entirely – far from it. In 2020, gilts did manage to act as diversifiers despite low starting yields. That led many wealth managers to warm to the asset class once again.
Our fund selection database shows that 60 per cent of UK wealth managers still hold a dedicated gilt fund in their model portfolio ranges. That figure drops only slightly, to 55 per cent, when looking at balanced portfolios alone.
And the time when it was gilts, specifically, that were causing investors alarm is now long in the past. In a typical balanced portfolio, the average gilt fund weighting is almost twice the combined allocation to US Treasury and global government bond offerings.
But one final point of note is that these weightings remain low in absolute terms. Fixed income accounts for around 25 per cent of a balanced portfolio nowadays, but gilt funds on average make up just 3 per cent of a portfolio. Fewer than one in 10 DFMs now has a double-digit position in either gilt funds or gilts themselves. The ‘nitroglycerine’ prediction may have been wildly inaccurate, but there’s certainly a degree of caution still at play among professional fund selectors.
A one-sided standoff
Another flash back to an earlier time emerged last Friday, via stock exchange announcements from the BH Macro and BH Global investment trusts.
In short, having agreed to cut fees in 2016 and 2017 following a period of underperformance, manager Brevan Howard has pointed to its healthy 2020 numbers and said it should return to a good old fashioned ‘2 and 20’ model. If not, it’s prepared to walk away from both portfolios.
There’s no doubt the trusts’ performance will have pleased holders last year: posting healthy gains in Q1 2020 was no mean feat. But the world has moved on since its fees were negotiated down. A demand for more money, justified or otherwise, is practically unheard of nowadays.
Both trusts count wealth managers among their major shareholders – and clearly this group, like most other players in the investment chain, have become increasingly cost-sensitive in recent years. So it’s no surprise that brokers are sceptical over Brevan Howard’s chances of success.
Both Liberum and Numis think a 1 per cent management fee might be an acceptable compromise (in addition to an existing 20 per cent performance charge) – the current 1 per cent fee is only levied on AUM as of 2017, meaning the actual charge is now closer to 0.65 per cent, according to Numis.
But the fund manager’s initial statement would seem to leave little wiggle room, and Liberum thinks a wind-up of both trusts is “the most likely outcome”. Brevan Howard looks content to walk away, but the end of its tenure would be a big blow to both the trust sector and a wealth management industry for whom real diversifiers are still a rarity. This will be a test case for whether those diversifying qualities are able to override premium pricing structures.
Special times
The surge in Spac activity is accelerating further. Five deals worth more than $1bn were struck yesterday as private companies continue to dodge the regular IPO route.
All this is a far cry from just 18 months ago, when the talk was focused on “the incredible shrinking stock market”. Armed with new incentives and a new method of going public, privately-held businesses have leapt at the chance to do so.
The relevant question for allocators is whether this frenzy represents a late-cycle activity that only emerges as markets peak. Even Goldman, which like many investment banks has reaped the reward of Spac fundraising activity, thinks current trends are unsustainable. All the same, investors will recognise the music can keep playing long after such calls are first sounded.