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DFMs prove reluctant to shun equity laggards; Can recovery plays stay in favour?

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Zeroing in

For many DFMs, the past six months have been a time to reconsider equity fund preferences, on both a stylistic and a regional basis.

Some are turning to thematic global equity funds more than ever before. Others – though the two groups aren’t mutually exclusive – have been dialling down US exposures, and looking again at the UK and other regions.

As we’ve discussed in recent weeks, many of those calls now look finely balanced. Almost all parts of the equity market can point to decent performance at some point over the past year; even the cheapest parts of the market are typically less cheap than they were a few months back.

That means opinion is as divided as ever when it comes to equity allocations. But while many portfolios are focusing on their biggest calls, it’s not a contradiction to say they haven’t fully abandoned regional positions, either.

In fact, the typical model portfolio is spread more broadly than it once was. Compare the situation now with that recorded just over 18 months ago, and there are far fewer DFMs opting to “zero weight” a given region.

As the chart shows, the proportion of portfolios with nothing in dedicated US or Europe funds has halved – and fallen even further when it comes to both Asia and Japanese strategies. In some cases (the US and perhaps Asia), this represents a strengthening of convictions. For Europe and Japan, it’s a reflection of how more firms are now taking neutral rather than underweight positions.

Only emerging markets have bucked the trend – and here, as was the case back in 2019, this is as much because fund selectors are becoming more specialised, and turning to Asia ex-Japan strategies instead.

Style shift

The value and momentum crossover moment is well and truly here. We first discussed this possibility in March, and in April noted that ETF rebalancings were around the corner.

The US momentum ETFs in question aren’t held by any DFM portfolios tracked by our database – but the change in their make-up does have a wider relevance.

These funds have now seen holdings like Amazon, Apple and Microsoft removed, with a host of US banks joining in their place. The extent of these changes has taken even analysts by surprise, according to ETF Stream.

Financials, for instance, accounted for 1.5 per cent of one particular momentum ETF prior to its rebalance at the end of May. A few days later, that same ETF has a 32.5 per cent weighting to the sector.

All of which will naturally lead the more cautious to ponder whether the dramatic run-up seen for such stocks can continue. Few would be willing to wager this is the start of a multi-year bull run of the kind seen for tech stocks. But there may be a connection there nonetheless.

Putting questions of valuation aside, part of the reason why many investors are holding US financials is, in effect, as a hedge for their existing growth-focused US equity positions. For those who take that barbell approach to the extreme, intrinsic value is arguably less important than these stocks’ roles as relative winners in times of tech trouble.

That isn’t a mindset that applies to DFMs, but some in the hedge fund world will be thinking in this way. And that implies a degree of continued support for recovery stocks, however much their valuations have risen.

Making the grade

The board of another out-of-favour investment trust has given up waiting for performance to improve: the £500m+ Scottish Investment Trust is reviewing its management arrangements.

But this review will take place in a different context to some of those seen last year. Returns posted by in-house manager Alasdair McKinnon have already started to improve. After a dismal few years, the trust’s commodity-focused global equity portfolio has rebounded healthily in 2021.

As such, the board faces a more difficult decision: the size of the portfolio suggests it’ll be pitched for by all manner of asset managers, most of whom will doubtless emphasise the merits of an ESG-focused approach. The board will have to ponder whether that represents a better bet for its retail-focused shareholder base than an old-fashioned cyclical approach.

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