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The reflation trade goes off the rails; High-risk portfolios set off down different paths

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Plot twist

The short-term market activity seen over recent days has been all about recalibrating long-term expectations. Investors are continuing to wrestle with the implications of the Fed’s latest dot plot, and not everyone thinks the conclusions make sense.

In the words of one commentator, speaking to Reuters on Friday, the market view has shifted from “'the Fed’s going to let inflation run wild’ to ‘the Fed’s basically going to kill inflation in the cradle’”.

Government bond prices reflect this shift from one extreme to another: 30-year Treasury yields this morning fell below 2 per cent for the first time since before the pandemic. The yield curve has flattened markedly, too, and the dollar has resumed its ascent.

It’s not just in the US: the UK yield curve has also flattened since the Fed announcement last Wednesday, in advance of the Bank of England’s own thoughts later this week.

The general flight from reflation trades will have upset a few applecarts, though it'll take more than a few days of price action to dislodge DFMs from their current positioning. We said earlier this month that the inflation debate was about to get more complicated, but few would have expected this kind of move so soon.

One continued source of solace for wealth portfolios is their credit positions. US investment grade credit spreads fell to their lowest levels since 2007 in the aftermath of the Fed meeting. Sterling corporate bond fund performance has been a little wobblier than that recorded by high-yield counterparts this year, but the overall picture for credit remains remarkably relaxed all told.

Patterns and outliers

With half the year almost done and dusted, wealth managers remain content with their lot. For all the pondering over government bonds, equity market rotations and the prospect of higher inflation, portfolios have sailed on unencumbered.

That will have kept clients happy. As ever, there are some DFMs whose portfolios are struggling to make good on their promises. But it’s easier to paper over those cracks when overall returns remain in the black rather than the red.

Most wealth managers’ model portfolios will hold the bulk of their client assets in balanced, cautious or defensive offerings. Here there’s been little deviation from the mean: our analysis shows the vast majority of balanced models have returned something in the region of 6.5 per cent over the past six months.

It’s a similar story for the most defensive models, which have managed to navigate the bond sell-off seen in Q1 and emerge in fairly uniform fashion. Six-month returns for this cohort are naturally lower, at around 2.5 per cent, but even here there’s been nothing in the way of negative returns.

The exception to this conformity can be found at the other end of the spectrum. The typical aggressive private client portfolio returned roughly 8 per cent between the end of November and the start of June, according to Arc.

But DFM returns vary quite significantly. Tasked with allocating the bulk of these portfolios to equities, wealth managers have opted for a variety of solutions – in keeping with a market where the regional equity and growth versus value debates remain live ones.

Stay tuned for more in the coming days, as we take a closer look at how exactly some firms’ aggressive models are deviating from private client benchmarks.

Selling up

JPMorgan’s acquisition of Nutmeg brings a familiar conclusion to the robo-adviser’s ups and downs since its launch in 2011.

The company has invested heavily in marketing and client acquisition, but moved further away from profitability with every passing year. One thing at which it's always proven successful, however, is raising money from investors. The acquisition by JPM is very much in line with that.

The question of when it will turn a profit now fades into the background, as attention turns to how the company will be used to spearhead JPM’s push into the UK retail banking market.

Of course, from wealth managers’ perspective, Nutmeg’s target market was always a step removed from their own. That won’t change with the arrival of a new backer. But those interested in whether robo truly can achieve critical mass will be monitoring how prominent a role it takes in the bank’s online operations from hereon in.

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