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The latest episode of the Asset Allocator Podcast is out now. James Penny, chief investment officer at TAM Asset Management, joins us to discuss how he's handling the increased correlation between equities and bonds, and the challenges of natural income.
Chasing the dollar
A dilemma for equity investors over the past decade or so has been that most of the stocks which performed best, including tech stocks, were those which paid little in the way of dividends, while many traditional income-yielding assets performed poorly in capital return terms.
Those circumstances, perhaps inevitably, led to US equities outperforming strongly since that market is not usually held for dividends but it presented a challenge for those whose priority is income.
Our database shows the average exposure to US equity funds in the income portfolios of DFMs we cover is 10 per cent. US allocation in the overall Asset Allocator database which covers growth and income is 15 per cent.
The allocator with the biggest holding in US equity funds in their income product is Evelyn Partners (the firm formerly known as Tilney Smith & Williamson) at 21 per cent, followed by Brewin Dolphin at 17 per cent.
At the other end of the spectrum, You, Hawksmoor and Wise have zero allocated to US equity funds in their income strategies, while Morningstar, with 3.5 per cent, and Iboss with 4 per cent, maintain sharp underweights.
As previously discussed, the JP Morgan US Equity Income fund is very widely held among DFMs and is in nine of the income funds on our database.
Indeed it has monopolised the space, being held more than all the other US equity income funds combined (the £234m Schroder US Equity Income Maximiser is its closest rival - held three times).
Even in our income database, there is a far greater proliferation of US growth funds than US income funds. There are only six US equity income funds in our database at all, and two of those are passives.
There are 16 total holdings in US equity income funds and 23 in US growth funds.
The Schroders fund has a yield of just shy of 5 per cent, and uses options to increase the dividend income. This is achieved by selling some of the future potential capital gain from a stock in exchange for a payment now, with the payment received now used to maintain the income distribution.
On a fund factsheet that makes it look as though the fund is short selling.
As the chart above shows, the two funds have performed relatively in line with each other, with the Schroders fund enjoying a period of outperformance when value was in vogue in 2021, but the gap narrowing in recent months.
The JPM fund has a much lower yield, barely reaching 2 per cent.
Best of times, worst of times?
The first half of 2022 saw a sea of red engulf investment markets, but while the latest Morningstar data contains much that is predictable (the best performing sector was the commodity-heavy Latin America, and best performing fund Guinness Global Energy).
It is also predictable enough that the absolute worst performing mandate in the first half of the year was the Baillie Gifford American fund, which lost an eye-watering 49 per cent, as that firm's avowedly growth style of investing took its toll in a market which has long since been selling off anything with interest rate sensitivity.
But it was notable that two absolute return funds performed strongly: Winton Absolute Return Futures and Clear Peak Capital UK Long/Short Equity. These funds returned 15 and 12 per cent respectively.
This suggests there may be hope yet for this much maligned sector (though you could argue whether a fund which is meant to produce an absolute return year-on-year should be blowing the lights out with its annual performance).
But if there is hope for absolute return funds, this is handy for allocators who are increasingly looking for options beyond equities and fixed income as these two become more and more correlated.
Indeed we discussed this very issue with James Penny, chief investment officer at TAM Asset Management, on the latest edition of our podcast, which is out today.