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Asset Allocator

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Yield farmers

Asset Allocator has lifted the covers from some of the corners of our databases in recent weeks, and the latest iteration of this work reveals that over the course of 2022, the DFMs we monitor have been increasing their allocations to high yield emerging market bonds and investment grade bonds at the expense of strategic bond funds. 

As the chart below shows, the portion of balanced portfolios held in strat bond funds fell over the course of 2022 to 3.89 per cent in October, having been as high as 4.47 per cent earlier in the year.

It is perhaps surprising that strategic bond funds, the mandates with the greatest scope to embrace flexibility in the asset class, fell from favour even as uncertainty levels across global markets increased. 

Surely at times like these DFMs might be more tempted to ask Ariel Bezelel, Stephen Snowden or John Pattullo to handle their bond allocations for them?

But it is in the choice of high yield and emerging market debt funds as the replacements that may reveal the reason.

The yields on such mandates have risen sharply throughout the course of this year so, for investors who view bonds as an income investment, 2022 suddenly provided an intuitive place to pick up high yielding assets after almost a decade where that was far from the case. 

And if yield is easier to come by, then perhaps it’s natural that would reduce demand for funds which build their process around flexibility and the ability to search far and wide across the asset class. 

Of course, emerging market debt and high yield bond funds are likely to be riskier and more volatile than strategic bond funds due to the latter being more diversified, but given the losses being nursed by those who owned developed market government bonds, and indeed the traditionally lower risk equities with which high yield bonds might be said to be correlated, this has not been a year where caution has been an especially rewarding strategy. 

The fact allocations to index-linked bonds were broadly unchanged during 2022, despite many allocators sharply revising their expectations around the scale and longevity of the inflation shock this year caught our attention.

That such revisions of opinion didn't prompt material increases in allocations to index-linked bond funds may give testament to just how much was already priced into that asset class as we entered 2022. 

The most widely-owned emerging market bond fund among the allocators on our database is M&G Emerging Market Bond fund, which is held in seven of the portfolios we cover. 

There has been one buyer and one seller of the fund this year, the fund is £750mn in size. 

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