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Something to link about as inflation bites; DFMs fail to feel samba beat

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Missing link

That there has been an increase in demand among allocators for index-linked bond funds is probably the least startling revelation that will cross your desk this month, so let’s focus on something a bit more interesting: the concentration of exposure to passive products.

Inflation-linked bonds usually reward an investor twice if inflation rises: firstly because a percentage equal to the prevailing inflation rate is usually added to the principal owed, plus the coupon adjusts to reflect the changes. 

Our data base predictably shows a stream of buy orders from DFMs, though interestingly a number of larger firms also sold in 2021, which has made this sector an active one in recent months.

The most widely held fund is the L&G Global Inflation Linked Bond Index, appearing in nine of the portfolios in our database. L&G’s Index Linked Gilt fund is also strongly represented, being in four portfolios. 

The only actively-managed fund to appear in more than a couple of portfolios, and the third most widely held overall, is the M&G UK Inflation Linked Corporate Bond fund, which is managed by Ben Lord and is held in three portfolios.

This is a fund with £1.2bn in assets but both L&G funds have left it in the dust over the past year. The M&G fund has returned 0.46 per cent while the L&G Index Linked Gilt fund returned 6.25 per cent and the L&G Global Inflation Linked fund returned 4.28 per cent.

The disparity is explained, at least in part, by the nature of the M&G fund itself. Both L&G funds invest exclusively in government bonds while the M&G fund styles itself more as a strategic bond fund (indeed it sits in the IA’s Strategic Bond Fund sector) and the majority of its assets are invested in corporate bonds.

Times have obviously been a little tougher for all three of these funds more recently, and they have all posted losses over the past three months - but the M&G fund has faced smaller losses than the L&G funds, at just 0.81 per cent (the L&G index linked gilt fund wins the wooden spoon, losing 3.98 per cent).

Perhaps investors concluded it was time to take profits, given the uncertainty.

Because almost all of the index-linked bonds in the market are issued by governments, and the vast bulk by the UK government, the only way an active manager can usually add value is through managing duration.

Given the reduced opportunities to increase returns from active management, it seems perhaps inevitable that most products favoured by DFMs are passive.

But perhaps the rewards (if slightly reduced losses can be called ‘rewards’) of the M&G fund’s slightly different approach show there can be a third way.

March of the makers

Data from FE Analytics reveals the best performing sectors in both the IA and AIC fund universe (excluding money market funds) in March were those related to Latin American equities, presumably due to the strong rally in commodity prices. 

The IA Latin America sector returned 14.5 per cent in the month, while the Commodities sector returned 10 per cent. 

If the market is rewarding makers, then times are tougher for consumers, with commodity-importing China providing the worst performing sector, losing 6 per cent in the month. 

The best performing markets over the month were the Topix Japanese market and the S&P 500, the latter being the less technology focused bit of the US.

There are four explicitly Latin American funds in our database - all of which are held by precisely no one (the one DFM to hold any of them sold Aberdeen Latin American Equity in early 2020 and Liontrust Latin America in late 2021).

Meanwhile there are five China funds held by DFMs, with Fidelity China Special Situations and Fidelity China Consumer tied as being held in two portfolios each (indeed the latter is a new entrant to our database, having been snapped up by a couple of allocators recently).

The makers may be doing well for now, but DFMs have placed a long bet on the takers.

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