Asset allocation: our expert analyses IFAs’ investment calls

In May, the New Model Adviser® team hit the road, touring Britain with a series of roadshow events. While advisers at the gatherings took a deep dive into financial planning best practice, business management and client psychology, they were also asked about their investment plans for the next year.

At each stop on the cross-country tour we asked IFAs to reveal their asset allocation changes for the next 12 months by anonymous vote. We combined the results to form a nationwide picture.

But were the advisers on the money? We put the results to one of Citywire’s top investment minds, Nisha Long, head of cross border investment research.

More than 30% of those polled are expecting to increase their allocations to global equities and this is filtering through to net inflows. Since the start of the year (January to May 2018), Citywire’s Equity - Global sector was the second most popular for net inflows in the UK peer group (which measures the flows into funds that are registered for sale in the UK). The sector had net inflows of £7.6 billion over this period.

Emerging markets have also proved popular among investors and inflows have totalled £4.9 billion for the five-month period to the end of May. Emerging market equities have the potential to offer the best returns in the market over the next few years but the choice of countries and regions are the key determiners of returns.

There are a few counties to be wary of, such as Russia and Turkey, which have underperformed during the recent weakness in emerging markets. Valuations are also hefty, especially within Indian consumer companies. Despite this, the long-term gains can be rewarding as the risk/reward can be offset.

Of those polled, 4% are increasing allocations to the US. For the first time in many years the Equity - US sector has had net inflows in active US funds, of £1.1 billion over the past five months.

This is a reversal. Prior to this, the sector had month-on-month outflows, with investors shunning active products for passives to gain their US exposure. However, active management is becoming more favourable.

Although just 4% of those polled are increasing allocations to the US, it is worth noting the majority of funds in the Equity - Global sector have, on average, 50% of their portfolios invested in US equities, which still enables investors to gain exposure to a strengthening economy.

Fixed income has come under pressure over the past year due to rising interest rates and inflation. In the current environment, finding yield is harder than ever before. And as political uncertainty lingers, investors have to be very selective in the fixed income market to reach their goals.

There have been sector rotations in the fixed income space and investors are turning their backs on lower-yielding products. They have turned to the riskier part of the bond spectrum such as high-yield debt and emerging market debt, which bring equity-like returns, with less risk.

These equity proxies are popular in this low-yielding environment, however there is still a lot of risk with investing in these areas, such as companies at higher risk of defaulting on their loans.

Two areas that were not as popular in the polls are US bonds (8%) and convertible bonds (6%). But convertible bonds may provide protection in inflationary environments and offer safety in a bear market. They allow investors to convert to equity when the stock increases in value.

Increasing allocations here may help shield some of the recent market volatility. The main drivers of high returns in convertibles, as well as high-yield debt, have come from energy-related sectors.

Increasing allocations to corporate bonds (32%) also feature highly in the polling. Investment grade corporate bonds fundamentals remain attractive and are currently benefitting from attractive valuations, especially within US corporates. However, there is evidence these valuations are becoming stretched and the returns may not justify the cost. But the class still offers diversification.

UK corporates, on the other hand, are being approached with caution as Brexit negotiations are thrashed out and are putting pressure on domestic corporates. UK companies with international exposure are faring well compared with UK domestic companies. Therefore a broad global corporate exposure is best to diversify away from country-specific problems.

Mixed assets have the added benefit of a one-stop shop for diversification across different asset classes. This asset class tops investor’s allocations around the time of volatility.

Gaining the most traction since the beginning of the year are products in the Mixed Asset – Flexible sector which, as the name suggests, have the ability to invest across all asset classes without any restrictions on how much can be invested.

In a recent Citywire research study on mixed asset products we found flexible products are highly correlated to equities. This was due to their high exposures to equity proxies in bond allocations such as high-yield debt, emerging market debt and convertible bonds. In turn, the risk profile of these mixed asset products is increased and investors may not get what they thought they were buying.

It is essential, therefore, extra due diligence on the underlying investments of these mixed asset products is undertaken. They may be more equity-like than you think, even in balanced products.

Some 28% of respondents are thinking of increasing allocations to ethical/positive impact investments. This rides under the umbrella of ethical, sustainable and governance (ESG) investments.

The popularity of these type of products has accelerated over the past few years and asset management companies have made a concerted effort to rebrand and badge up products as ethical.

The underlying strategy may not have changed and, in some instances, it would be wise to look at why the name of a fund has been changed and if the strategy has the ethical representation to reflect the change.

Definitions within ESG products can differ widely. Therefore it is essential to research underlying investments to ensure the product is doing what it says on the tin and meets clients’ ethical requirements.

Finally, 5% are increasing allocations to alternative Ucits. These are hedge fund-like strategies and the main attraction is capital protection in downside market.

However, funds in this asset class have come under increased scrutiny as some of the most popular have failed to deliver on their capital protection remit. This justifies the lower levels of allocations to this asset class as advisers approach with caution.