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Asset Allocator

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How discretionaries' fixed income positions stack up; An unreliable metric returns to form

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Common bonds

If wealth managers are split on how best to allocate to alternatives, is there any more consensus when it comes to fixed income? Here, too, providers have started to offer an array of different options in recent years. Yet many selectors’ bond-buying strategies haven’t changed much at all.

The chart below replicates yesterday’s alternatives effort, this time showing the average Balanced portfolio’s typical weighting to various fixed income sectors. It shows that the three core areas for DFMs – government bonds, investment grade credit, and strategic bond funds – are each more popular than any part of the alternative asset universe:

That’s in part because the average portfolio has more in fixed income (23 per cent) than it does in alts (14 per cent). But it also speaks to the enduring success of these asset classes. Each faces its own challenges: persistent concerns over a yield spike, worries over correlation, and potential issues with taking on excess risk.

The first of these is the most widespread fear - but as chart 2 shows, two thirds of DFMs are still happy to have some conventional sovereign debt exposure.

As a result, discretionaries have proven relatively reticent to invest heftily in other types of fixed income fund. Absolute return bond funds – which we've classified as fixed income rather than an alternative asset – are still a footnote at best.

Even short-duration strategies have an average weighting of just 1.5 per cent– and, per the chart above, they’re held by barely one in four moderate portfolios.

Only inflation-linked funds are managing to gain a foothold in current allocations. Around half of all moderate portfolios now have some exposure here – unsurprisingly, that proportion’s risen notably since the start of 2021.

Getting results

Despite renewed macro jitters, earnings season optimism has once again proven correct. As a result, the percentage of buy ratings issued by US analysts has reached its highest level in almost two decades, according to Morgan Stanley analysis.

The early signs point to similar successes in Europe: as of last Thursday 63 per cent of companies had beaten on earnings per share and 67 per cent on sales, according to Bank of America.

The question is whether any of this really matters so much. The Q1 earnings season in the US was marked by something of a disconnect from reality. Results “couldn’t matter less to the market’s current valuations”, Bloomberg said at the time.

Even the common refrain to focus on guidance had become stretched: the newswire reported that markets were pricing in profits that were virtually impossible to materialise.

This time around, however, there are signs that earnings have become more important. SocGen’s global quantitative research unit notes it has “really paid to follow…analyst upgrades, particularly in Europe”.

The team’s custom-made earnings momentum factor index has outperformed this year, having captured both the value rally and the subsequent quality-stock rebound.

That might prove a promising sign for sectors that have seen a raft of upgrades of late. Tech is one of those, but so too – despite the nervousness over the recovery – is mining. SocGen notes the sector saw “large upgrades” in July.

Office incentive

As far as employee incentives go, a fund manager giving all staff members who’ve been vaccinated a $1,000 bonus has to rank right up there. And certainly UK fund selectors may have one or two questions of their own on this front.

Needless to say, the much higher uptake rates on these shores means such policies are unlikely to catch on over here – at least not for older workers.

Nonetheless, the prospect of a (slightly) more widespread return to the office in the autumn means face-to-face meetings is a realistic option again. If vaccine passports do gain ground in the UK around the same time, the idea of asking whether all attendees have had the jab might not be that outlandish either.

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