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Fixed income flows give DFMs much to consider; Is UK's double discount receding?

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New year hangover

Baillie Gifford has always worn its growth credentials as a badge of honour, so it is perhaps no surprise that amid the current sharp market rotation towards value, the Edinburgh fund house suffered its worst month on record, with assets down 10 per cent.

Of that 10 per cent drop, 1.3 per cent was outflows. That may sound trifling, but in cash terms that’s £875m - and most of us would notice if that sum of money suddenly walked out of the door.

The firm is probably best known for its investment trusts, and a chunk of the decline in assets will be accounted for by the deterioration of Scottish Mortgage - arguably one of the most famous investment vehicles in the country.

The trust’s shares have lost about a third of their value this year - but don’t weep too much because it’s still some £17bn in size. 

In terms of open-ended funds, Baillie Gifford is probably best known for its Global Alpha and American strategies. 

Our database shows that, while allocators prefer to keep things passive for their US equity exposure, Baillie Gifford American is the second most popular active mandate behind JP Morgan US Equity Income, which we discussed last week and which has had some performance issues of its own.

The respective performance of these two funds over the past few years - with Baillie Gifford flying to the stars and crashing back down to earth - is a sign of the brave new world 2022 has become for growth stocks in general and US stocks in particular.

But strangely, despite the market being supposedly in the teeth of a strong value rally, UK equity funds were just as unpopular with investors as the US, with a net £3.5bn withdrawn between the two sectors over the course of the month.

Indeed fixed income funds attracted net inflows of £816m, despite higher inflation and the looming end of bond buying programmes from central banks. 

This continues a theme of fund buyers acting in defiance of what the macro environment might suggest, as we discussed a few weeks ago in respect of their negative stance on emerging markets.

How long a rally in value stocks can last when market participants are allocating around six times more to bonds than equities is something for allocators - and Baillie Gifford - to ponder in the months ahead.

Dark clouds

The curious case of investors turning to bonds at the same time as inflation hits new highs might be explained by data from the latest Bank of America European fund manager survey.

It shows 20 per cent of respondents expect the global economy to weaken this year - an enormous increase on the 1 per cent who held that view in January.

Given those views, it’s perhaps not surprising sentiment toward equities has declined sharply, with a drop of 24 percentage points in the number of managers who think equities could rise by at least 5 per cent in aggregate over the course of the year.

However, it is worth emphasising the persistent majority view (57 per cent) that equities will do well, while 18 per cent expect equities to decline. 

The managers view the unwinding of QE by central banks as the biggest threat to markets this year, with higher bond yields expected to hurt multiples and inflation expected to damage company earnings. 

Perhaps the most eyebrow-raising finding from the data is that the UK is now the favoured equity market. 

Of course the FTSE has benefitted from being replete with value stocks, particularly miners and oils, but continental markets tick most of those boxes as well. 

Could it be that the supposed double discount at which the UK market traded - the value discount and the Brexit discount - could be receding from view?

Refuse to yield

The hunt for yield over the past decade has pushed investors into taking more risk than is wise, according to portfolio constructors and asset allocators in the US surveyed by Natixis.

In terms of what to do about that risk, the allocators are sticking with fixed income but also looking to increase exposure to infrastructure and private equity as a way to find yield. 

One allocator who has completely fled bonds is James Barton at Featherstone, who says bond prices are so that high investors are "guaranteed to lose money".

He added: "Investing in other risky things doesn’t seem so bad, as you only might lose money with those."


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