Hunker down or full steam ahead? Part II

  • Date: 26/09/2018
  • Author: Jordan Sriharan
  • Source: Investment Week

Hunker down or full steam ahead? Part II

In last month's piece I set the scene for the key issue facing today's multi-asset investor - where are we in the economic cycle? In this second part, we look at how active managers are re-shaping their fixed income and equity portfolios in order to navigate choppier waters.

Bond managers are typically more cautious, understandable given the marginal upside potential and the significant downside risk. For UK sterling corporate bond managers, the outlook is uncertain, leading to more discrepancy across portfolios.

Some remain bullish, expecting credit spreads over gilts to compress again. With no obvious economic deterioration in the offing, these managers expect an element of mean reversion to support shorter-term returns. 

Others have turned bearish. In their portfolios they have reduced duration times spread (DTS), which equates to bringing down credit spread risk. They have increased their exposure to high quality government bonds whilst moving up in overall credit quality.

Their sector biases are also shifting, so where they were knee-deep in subordinated financials they have retreated towards the non-cyclical sectors, focusing on credits with more stable earnings profiles.

Meanwhile, equity managers are more bullish but are reducing risk at the margin. Some of the more 'valuation' driven managers are now extolling the virtues of an approach that does not chase growth stocks at any price; a motto that would serve most well wherever we are in the cycle.

For growth managers, those who have turned more bearish are trimming gains and recycling back into underperforming names as well as building small cash buffers.

Looking across the discretionary fund manager (DFM) peer group reveals two trends for those preparing to bunker down. The first is the move back towards active equity managers after almost a decade of empire-building by the passive providers. In particular, DFMs are allocating to active US equity managers, less exposed to the 'growth-like' and tech names in the S&P 500. Having underperformed the index for so long, those active managers that have remained true to their investment style are beginning to see rewards.

The second trend is towards increased exposure to developed market government bonds. Since the introduction of QE, the asset class has been scorned by the multi-asset investor as a low-yielding position.

However, it appears DFMs are returning to first principle portfolio construction rules and allocating to government bonds for their risk-mitigating properties.

This backdrop leaves the fortunes of equity, fixed income and multi-asset active managers finely poised. With positioning more polarised, there will be clear winners and losers in the short-run.

For those with strong longer-term performance the decision to be more defensive is easier, but for those still playing catch up it is a tough call.

Performance when the cycle turns will be the key differentiator when clients eventually re-assess their options.

Jordan Sriharan

Head of Collectives Research and Senior Portfolio Manager

Article first appeared in:

Investment Week (20th September 2018)

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