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Asset Allocator

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Dramatic times prompt jump in DFM fund turnover; The no-go areas for passives

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Bye or hold

In a year that’s so far been characterised by rapid trading activity, the attitudes of professional investors like wealth managers look more distinct than ever. DFMs are fleet of foot when they want to be, but in the main they tend to be buy and hold advocates – particularly where collectives are concerned.

Last year, clearly, tested the mettle of even the most committed fund buyer. A pandemic was not a scenario factored in to fund selection models. While successful vaccine trials were at least a known unknown, they too nonetheless prompted a new period of reconsideration.

To examine how this has been reflected in portfolio turnover, we’ve turned again to our fund selection database, and compared 2020 buys and sells with those seen in 2019. We start today by looking at bond fund picks.

For context, 2019 did have some drama of its own. While all things seemingly pale in comparison to the past 12 months, investors did encounter some surprises back then as well - chief among them the sudden change of course at the Federal Reserve.

And while bond markets didn’t exactly have a smooth time of it last year – credit in particular saw a sharp sell off and rapid rebound – fixed income funds were less affected by the talk of market rotation seen in Q4.

Nonetheless, our analysis shows there was a notable uptick in turnover in 2020. The average DFM either introduced or divested 3.9 bond funds from their model portfolio ranges last year, compared with an average of 2.6 last year. The shift is even more stark when looking at the median number of changes: 3.5 compared with two in 2019.

Most firms stuck pretty closely to these averages, but there are always outliers. Some did feel comfortable enough to stick with their knitting: 18 per cent of our sample made no changes in 2019, and 11 per cent made no alterations last year. The buy and hold mentality was still pretty strong when it came to bonds – next week we’ll examine how equity holdings fared under the glare of market volatility.

One of a kind

When it comes to turnover, the rise of ETFs is frequently blamed for an increase in trading activity. From UK DFMs’ perspective, while it’s certainly true that ETFs are used as tactical tools, that’s far from their only use: many are held for just as long as open-ended funds.

That’s particularly the case in the bond fund universe, where both trackers and ETFs have effectively replaced active funds entirely in some vanilla asset classes.

But not all passive bond options are so useful, according to analysis from Ashmore last month. The fund house’s research suggests just 13 per cent of the world’s stock of emerging market debt are currently included in flagship bond indices.

Ashmore does, of course, have a range of active rather than passive EMD strategies on offer to investors. Its stake in the argument was already clear prior to this research. And from UK fund selectors’ point of view, the asset class isn't particularly unique.

Of all the EMD funds held by discretionaries, 19 per cent are passive. That doesn’t sound like much – certainly not when compared with the 63 per cent market share for passive inflation-linked bond funds, or the 80 per cent accounted for by gilt trackers and ETFs.

But it is broadly comparable with the 21 per cent share of corporate bond picks, and above passives’ 12 per cent share of high-yield options. The conclusion is this isn’t so much an EMD story, as one showing fund selectors still have reservations about passive picks in several areas.

Fed the right lines

To conclude today’s bond focus with a return to markets themselves: the Fed seemingly passed another test overnight by again emphasising its commitment to keeping monetary policy looser for longer.

After some recent jitters over prospective moves in inflation, Jerome Powell stressed the central bank’s attention remains on unemployment – and to that end, stated the labour market is “very far” from being in a strong position.

That reassurance may not be too long-lasting, however: it’s the prospects for several months from now that continue to excise certain bond investors. For the rest of the year they’ll be listening to Powell’s every word for any sign of deviation.

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