However, rather than put this to work in equities, a sense of caution remains with fixed income being the main beneficiary as exposure to bonds jumped from 44.3% to 47.91% quarter-on-quarter. Equities stayed steady at 27%, while alternatives fell slightly from 14.7% in June to 13.56%.
This trend was reflected in recent IA net retails sales, which in May and June showed a move away from UK equities (with hefty outflows in the IA UK All Companies and UK Equity Income sectors), to the safety of bonds, as investors remain cautious on the prospect for their own domestic markets.
Mixed messages
Ben Kumar, an investment manager at Seven Investment Management (7IM), says the mixed messages currently coming out of financial markets are “concerning”.
“Quality government bonds look expensive – prices appear to be extrapolating today’s low interest rate environment almost indefinitely into the future,” he says. “But central banks are indicating that their overall intention is towards raising interest rates.
“Equity markets seemingly agree with central banks’ optimism and are moving higher still, despite record high valuations, given the positive economic and earnings data. But at some point, these different views will need to reconcile. Geopolitical risk is also heightened in more than one region.”
Faced with this, Kumar says that 7IM remains cautiously positioned, both in fixed income duration and equity markets.
“We are prepared to forgo gains in fixed income that are predicated on low rates, just as we may lag a further step up in equities that increasingly seem to be ignoring downside risks precisely when they seem to be increasing,” he says.
As a result, 7IM is adopting underweight positions in equities and bonds (although it holds some US treasuries) and is overweight in gold and alternatives.
“Our investments in infrastructure funds should provide a source of steady stable returns, while market-neutral alternative investments should remain relatively immune to the short-term rises or falls in the other major asset classes,” he says.
Selection matters
While it is widely accepted that asset allocation is the driving factor behind investment returns, Chris Rush, senior investment director at Iboss, contends fund selection can be just as important to a fund’s ability to outperform its benchmark over the longer term.
“By selecting managers who have the widest possible remit, no reluctance to hold cash or safer assets, and an emphasis on risk-adjusted returns, a large portion of the overall asset allocation can be outsourced to the underlying fund managers,” he says.
“By focusing on fund managers with strong risk-adjusted characteristics (as measured by Alpha and Sharpe ratios) and avoiding those managers that are generating performance predominantly high beta/market risk, you can be assured the fund managers selected have genuine demonstrable skill.
“A wide selection of truly skilled fund managers will give an overall portfolio a dynamic asset allocation that changes on almost a daily basis.”
While this may sound obvious, Rush says trusting the underlying managers and the selection process is vital, and more difficult than it may sound.
“In our experience, some multi-asset offerings seem to devote large amounts of time basically second-guessing their fund managers and making counter-intuitive asset allocation positions to ‘hedge’ the underlying manager positions,” he says.
This isn’t to say that Iboss ignores asset allocation altogether and he says they arguably have an advantage looking holistically compared with a manager consigned to a specific geography or sector.
“On this basis, we have marginally increased the explicit cash positions across our range to reflect our defensively orientated global outlook. This is supplemented by the increasing cash positions of the underlying funds.”
