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Asset Allocator

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Long/short funds put skin in the game; ESG makeovers have ugly results for DFMs

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A sense of longing

Market dislocations tends to invite the hope that active managers can take advantage of heightened inefficiencies, and that’s an argument we saw return even before the new year sell-off.

With many assuming this year would prove trickier than 2021, a number of the 12-month outlooks authored at the dawn of 2022 used "selectivity" as a watchword.

One extension of the focus on selectivity is to go beyond conventional long-only equity investing. When it comes to short sellers, some will be hoping for better fortunes after a year of burnt fingers

For long/short funds, the picture here is pretty mixed right now. As the chart below shows, those strategies most closely followed by the DFM community appear to have broadly resisted any urge to make wholesale changes in the last quarter - though this may be a misleading impression.

As we’ve seen before, these funds have mainly been content not to shift net exposures too far. It’s only Sanlam Enterprise and Majedie Tortoise who really stand out, having notably reined their net exposures in.

Net exposures aside, another metric may be more telling. Both the Sanlam and Majedie funds have ramped up their gross exposures, suggesting heightened activity on the shorting front.

More generally, eight of the 11 funds listed above have upped their gross exposure in the last quarter - pointing to more skin in the game, if the previous balance between long and short is roughly maintained.

As far as performance is concerned, the Majedie fund has notched up some healthy gains amid the volatile opening weeks of 2022, with mixed results for others. Further volatility could bring vindication.

Unhappy customer

As the 2021 post-mortems continue to dribble in, we’re only seeing further confirmation of some of the biggest trends. ESG is pretty high on that list: a Morningstar round-up of UK fund flows notes that sustainable funds "dominated" 2021, with the volume of money into such products actually outpacing total new flows for the whole market.

That assisted a shifting market dynamic, with the interest in sustainability helping active funds attain higher inflows than their passive rivals for the first time since 2014.

ESG is of course making waves on the passive front too: when it comes to ETFs, separate Morningstar data shows 51 per cent of European flows for 2021 going into ESG products. This trend has accelerated further thanks to providers revamping funds as ESG offerings.

And here lies the rub. Ignites Europe noted earlier this month that some fund selectors had grown disgruntled with passive providers opting to give their strategies an ESG makeover. In one case, a selector was unhappy that an ETF they held had switched to an ESG index that excluded Shell. Another example points to more customer-centric issues and a lack of notification that such changes were occurring in the first place.

On the investment front, these grievances may well illustrate just another dividing line on the ESG front. Opinions differ on the merits of exclusionary policies versus engagement, and some allocators may simply want simple exposures unhindered by any screening criteria. With further progress due on the labelling of funds by their approach to ESG, making such choices should become easier over time.

Stress test

With yields on the rise, bond markets have been setting all sorts of unusual records this month. First we had a notable fall in the level of negative-yielding debt. Fast forward a few days and Bunds decided to join the party, with yields briefly moving into positive territory.

As we’ve noted, at some point valuations may well become supportive. But with the average UK gilt fund down by more than 2.5 per cent three weeks into the year, selectors will also wonder where any fixed income resilience can be found.

Of the sterling strategic bond funds on offer, there’s some inevitable dispersion between those that serve as diversified plays on high yield and more defensive names. At the time of writing Invesco Tactical Bond was the only name in the black, while funds like Artemis High Income were among those with the lowest losses. But some of the big names making use of government bonds have not fared too badly. We’ll be looking at exactly how these funds are positioned in the coming weeks.

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