UK advisers are running underweights to parts of the market that have rallied hard over recent years while drifting away from the traditional ‘balanced’ model of asset allocation, research by Vanguard has found. 
The asset management house has reviewed 91 portfolios submitted by UK financial advisers between 1 January 2020 and 10 November 2020, all of which were ‘balanced’ or allocated approximately 60 per cent to equities.
A “key finding” of the analysis was that advisers appear to have drifted away from the 60 per cent in stocks and 40 per cent in bonds split that has stood as the classic balanced model for decades.
While the portfolios still had around 60 per cent allocated to equities, Vanguard discovered a “notable shift” within the non-equity portion of adviser portfolios.
Bond funds make up just 31 per cent of balanced portfolios now, while advisers have 5.1 per cent in cash and 5.8 per cent in ‘other’ asset classes. These other assets include commodities, direct property, private equity, hedge funds and long/short and market-neutral strategies.
The firm noted how these assets delivered mixed returns over 2020, with gold rallying as investors sought out safe havens in the coronavirus crisis while oil tanked as demand dried up. In addition, many UK property funds were suspended as a result of the pandemic.
Vanguard strategists said: “We agree that there are instances where non-traditional asset classes can offer benefits. However, before allocating to alternatives, advisers must address whether these investments will deliver benefits over the long term that justify their higher costs, greater complexity and more limited transparency and liquidity.”
Within portfolios’ equity allocations, UK advisers allocated approximately 91 per cent to developed market equities in 2020, with the remaining 9 per cent in emerging markets. This is in line with the global stock market.
However, the research found significant deviations when it comes to individual countries. The biggest was a bias towards the UK (which is to be expected) and a large underweight to the US.
Source: Vanguard
This was important in 2020 as global equity markets were led by the US, which has set several new record highs on the back of massive stimulus from the Federal Reserve, increased hopes of a resolution of the trade war with China and a sharp rally in technology stocks.
At the same time, the UK market’s concentration in cyclical sectors such as oil & gas, alongside the uncertainty over Brexit, means that the UK has underperformed – as have portfolios with a bias towards it.
“The UK equity market’s clear underperformance relative to broad global market-cap benchmarks this year brings into focus the potential impact of home bias on a portfolio,” Vanguard said.
“The familiarity and lack of currency risk associated with one’s domestic market may be comforting and indeed consistent with a client’s objectives. However, such an over-concentration can out- or underperform the global equity index depending on whether domestic stocks are in or out of favour during a particular market cycle.
“If a home bias is consistent with clients’ risk profiles and financial plans, then a period of underperformance may not warrant a portfolio construction change. We encourage advisers to maintain diversified portfolios across asset classes and regions, in line with their long-term investment goals.”
The overweight to the UK and underweight to the US also impacts adviser portfolios’ sector allocations.
As the chart below shows, UK clients’ portfolios were underweight to technology stocks by approximately 4 percentage points on average in 2020. This area of the market has surged during the coronavirus pandemic.
Source: Vanguard
What’s more, these tilts towards different geographies and sectors can also influence a portfolio’s exposure to different investment styles.
UK clients’ portfolios have a significant underweight towards large-cap growth stocks, which have performed strongly this year. Indeed, portfolios tend to have more in value – which has struggled for some time – than in the outperforming growth style.
They are also overweight small-caps, which have underperformed large-caps this year as investors worried about the health of the global economy.
Source: Vanguard
“Our research suggests that a balanced, strategic mix of styles has historically performed well versus cycle-based style-timing strategies,” Vanguard’s study said.
“While historical data reveal that certain factors have tended to do better than others in specific environments, a cycle-based style-timing strategy founded on historical performance may not live up to expectations because of inconsistent factor performance in different cycles. Investors must also gauge their ability to accurately identify the key inflection points in economic and financial conditions.
“We recommend that, as always, advisers apply rigorous due diligence when assessing the validity of a strategy. In the case of cycle-based timing strategies, due diligence plays a vital role in helping to identify hazards, such as hindsight bias, that can greatly exaggerate potential returns.”
When it comes to the fixed income elements of portfolios, the research found a tilt towards shorter-duration bonds, given the low interest-rate environment,
Yield curves have flattened during the past three years, leading to little yield compensation for the added risk of investing in longer-dated maturities and pushing advisers towards the shorter end of the curve.
But Vanguard added: “While longer-duration bond funds may not provide as attractive yield opportunities as they once did, they can still act as a risk-reducing diversifier within a multi-asset portfolio.
“Advisers should therefore be mindful of the role they want their fixed income allocation to play. If they are using fixed income funds as a risk ballast within the portfolio, then shortening duration may not meet this objective.”
Advisers were also overweight corporate bonds and underweight government bonds relative to the global market-cap fixed income index. With interest rates at record lows, some investors have questioned the value in holding government bonds.
However, global government bonds outperformed their corporate bonds during the coronavirus sell-off and helped to protect multi-asset investors from the heavy losses that hit the stock market.
“While government bonds may not offer appealing yields, they can still act as a shock absorber during equity drawdown periods. We encourage clients to keep the entire portfolio in mind when incorporating high-yield bonds into a balanced portfolio,” Vanguard finished.