UK financial advisers and wealth managers have reduced equity exposure across their model portfolios during the first quarter, according to research from Natixis, with emerging market and Japanese equities suffering the biggest drop in interest.
Instead, advisers seem to have been seeking solace through targeted absolute return funds, and “allocation funds” – or actively-managed investment vehicles – which the firm said shows a reduction in risk-taking across the board.
The findings come from Natixis’s latest UK Portfolio Barometer report, which is published quarterly and analyses the positioning of model risk-rated portfolios run by the financial advisory and wealth management industry.
These model portfolios (the firm looked at 97 in total in its recent report) are divided into three risk-adjusted groups; ‘conservative’, ‘moderate’ and ‘aggressive’ based on the definitions of the companies themselves.
Compared to Q4 last year, ‘conservative’ and ‘moderate’ portfolios have seen a 3 per cent reduction in their equity exposure, followed by an approximate 1 per cent reduction in the ‘aggressive’ portfolios.
Quarter change in asset allocation across risk-rated categories
Source: Natixis Portfolio Clarity
“Over the first quarter of 2017, investors lowered exposure to equities and increased exposure to allocation and alternatives across all three risk-rated categories,” the report noted. “This in isolation implies a reduction of risk across the categories.
“‘Conservative’ models appear to have shifted out of equities (mostly from emerging market equity) and the money market and into fixed income, allocation, alternatives and real assets.
“In real assets the shift was predominately into UK direct property funds (perhaps a signal that investors are returning to this sector after the liquidity restrictions imposed last summer). This can be seen as ‘conservative’ models reducing risk in equities while also reducing cash levels, and have been collectively adding to intermediate risk between equity and money market sectors.”
While ‘moderate’ portfolios also shifted out of equities, they reduced their fixed income exposure compared to Q4 last year and have instead upped their exposure to ‘allocation’ and alternative funds.
A majority of the shifts into actively-managed funds were into those with an income focus, while targeted absolute return funds dominated their exposure to alternatives. The report found that, within the targeted absolute return space, ‘moderate’ portfolios were focusing the smaller, more nimble funds in the space as opposed to the more behemoth, well-known names.
While there were few changes across ‘aggressive’ model portfolios in terms of asset class allocation, their movements within equities have been substantial throughout the first quarter of 2017 compared to Q4 last year.
As shown in the below chart, ‘aggressive’ portfolios tended to move away from emerging markets and Japan in favour of US and UK equities.
Quarter change within equity across risk-rated categories
Source: Natixis Portfolio Clarity
“Data showed flows into North American equities were positive over the first quarter. However, the higher number is predominantly made up from inflows in February, which compensated for lower January and March figures,” Natixis explained.
“This uptick in inflows coincides with very positive market sentiment in February as the ‘Trump reflation trade’ appeared to be gaining momentum with the review of Dodd-Frank potentially freeing up investment bank trading activities; Trump’s $1trn request to congress for infrastructure spending; and other simulative policies.
“These tended to overshadow negative events such as continued investigation into Russian involvement during the election campaign; the change in stance on Obamacare and the temporary travel ban imposed to name a few.”
In contrast, ‘moderate’ portfolios – while also reducing their emerging market exposure – actually increased their average allocations to Japanese equities by 3 per cent and slightly reduced their exposure to US equities compared to their positioning at the tail-end of last year.
Both ‘moderate’ and ‘aggressive; portfolios upped their exposure to UK equities, however.
“The conflicting allocations within ‘moderate’ and ‘aggressive’ models in Japan can be explained by an increase in ‘moderate’ model exposure from a low existing weight and a decrease in ‘aggressive’ model exposure from a high existing weight,” the report added. “There was a slight positive change in ‘conservative’ models.”
It highlighted that outflows from Japan funds during March were significant generally, which it said could be the result of a “much-publicised announcement of a merger proposal with another asset manager”.
Elsewhere, the report found that Europe ex UK funds suffered a reduction in exposure across all three risk categories. It reasoned that the Dutch general election in March and the first round of the French presidential election were likely to have been contributing factors to this. It also said firms could have been taking profits, given that European equities have performed well over recent quarters.
Performance of index over 1yr
Source: FE Analytics
“We’ve written about currency effects previous Barometers – to one extent or another. Little has changed in this regard, as currency continues to be a serious risk consideration in adviser models,” the report continued.
“For instance, the drawdown profile can be quite different when investing in hedged and unhedged versions of a fund.
“What is evident in the data is that a UK investor would have had a less aggressive drawdown profile investing into European equities with the currency unhedged. The weakness of sterling has been beneficial to UK investors. Valuations in European equities are relatively attractive when compared to the US. What warrants consideration though is whether currency risk is going to have a positive or negative impact to accessing these relatively attractive valuations.”
Over in fixed income, the team said it was surprised to see an increase in inflows – particularly into UK and UK-biased fixed income funds – during the first quarter of 2017.
While there have indeed been widespread fears regarding rising inflation and bond yields this year, the report pointed out that index-linked bonds saw the largest inflows while strategic and high yield bond funds saw the biggest outflows.
“With relatively disappointing returns in recent years we have seen a shift from strategic bonds into alternatives and real assets,” Natixis said. “Ultimately, this gives access to a higher return potential and given that fixed income volatility has increased, alternatives and real assets may offer similar levels of risk but with better return potential.”
The firm’s data over three years showed there was a definite trend between increasing risk and higher returns. That said, there is significant variability in terms of the positioning of the risk-adjusted portfolios relative to peer averages. The team expects this, given adviser views on what is conservative, moderate and aggressive varies widely.
“Over the long run, we expect ‘conservative’, ‘moderate’ and ‘aggressive’ models to have increasing risk and return relative to each other,” Natixis continued. “What is interesting is that in the recent quarter ‘aggressive’ models have not delivered higher returns than ‘moderate’ models given their relative risk profile.”
“However, one quarter is too short a period to make any conclusion and it highlights the short-term variability in results – nonetheless, the PRCG [Portfolio research and Consulting Group] team will continue to monitor this to see if this continues to be the case.”