Multi-asset fund exposure was reduced in favour of fixed income funds in UK cautious and moderate model advisor portfolios in Q4 2015, according to Natixis, with government bond exposure alone doubling compared to Q3 exposure.
In the firm’s latest Portfolio Barometer report, which analyses 210 model risk-rated portfolios managed by UK financial advisers and wealth management firms, it found that cautious portfolios held an average of 35 per cent in fixed income, moderate portfolios held 18 per cent in the asset class and aggressive portfolios held just 4 per cent during Q4 last year.
Compared to Natixis’ Q3 report, this was a 7 per cent increase for conservative portfolios, an almost 4 per cent increase for moderate portfolios and an approximate 2 per cent increase in aggressive portfolios.
This may come as a surprise to investors as, over the last year or so, fixed income assets have been largely unloved due to higher risk levels, lower yields and higher valuations leading to a deterioration of their former ‘safety net’ reputation.
Performance of sectors over 1yr
Source: FE Analytics
Another factor that may be surprising to investors is that government bond exposure across all three risk types in the Natixis survey increased from 1.6 per cent to 3.2 per cent, despite the fact that nearly $7trn of the $58trn total global government debt is now trading at negative yields.
In an article published yesterday, manager of the Murray International investment trust Bruce Stout said that today’s investing landscape was unchartered territory and has never been witnessed before, even by the most experienced investors.
“Absurdity descended into farce in Europe [in 2015]. Prevailing negative bond yields witnessed savers paying heavily indebted European governments for the privilege of lending to them – extraordinary to believe, guaranteed capital-loss investment proved popular amongst bond investors in Europe throughout 2015,” he said. 
Tristan Scrivens (pictured), director at Elm Financial Management, says this shows a complete lack of confidence among advisors that interest rates will increase any time soon.
“If you’re buying in at gilt rates at the moment, which are incredibly low, you’re pretty cautious and don’t think much is going to happen over the next few years,” he said.
“Then you have to ask what their strategy is for getting rid of these things. Once the interest rates do go up, they’re essentially worthless.”
Steve Lennon, investment manager at Parmenion, points out that government bonds are valuable within a diversified portfolio as both a safe haven asset and as one of the few assets with a negative correlation to equities. As such, he believes that a short-term tactical move into the asset class is understandable given heightened market volatility and toppy equity valuations.
“On a long term view, government bonds are likely to offer a negative total return after inflation so a longer term strategic position is more surprising,” he added.
Interestingly, the conservative and moderate model portfolios in Natixis’ survey decreased their exposure to multi-asset funds on average between Q3 and Q4 last year in order to make room for fixed income exposure.
Average change in allocation between Q3 and Q4 2015
Source: Natixis
The report also calculated the best and worst-diversified portfolios out of the 210 models by simulating their performances over three years and analysing a combination of their annualised volatility, maximum drawdown, Sharpe ratio, undiversified volatility and average diversification benefit.
It found that the most diversified portfolios achieved higher returns with lower risk metrics and also concluded that the best-diversified portfolios had higher weightings in alternative strategies such as direct property and long/short equities.
On the opposite end of the spectrum, those with a high number of multi-asset funds were less diversified on average – Natixis warned that these funds often have high correlations to the wider portfolios as they sometimes replicate the processes of the adviser or wealth manager.
Neil Jones, investment manager at Hargreave Hale, said: “Regarding multi-asset funds, I feel this adds little to a well-diversified portfolio and I prefer the greater flexibility which can be achieved from being in control of asset allocation.”
“In terms of replacing this weighting with fixed income, it does seem a strange time to be making a significant increase in the sector for cautious clients, or indeed for any clients. Whilst interest rate rises look further away now, ultimately it can only go one way.”
“I can see how some people have been drawn into this area over recent months as stock markets have been so volatile, but I feel this sector is looking relatively unattractive over the next few years.”
As an alternative, Jones says that investors may wish to consider convertible bonds instead, which he has been increasing clients’ exposure to as a means of capturing any recovery in stock markets. Ultimately though, he says that it depends on the sort of risk that the adviser is trying to manage.
“If you buy direct bonds you do at least have certainty of return, even if those returns are relatively modest, so a proportion of a well-diversified portfolio makes sense. Bond funds are less attractive, as here there is no redemption value so the downside is far greater,” he added.
“Whilst the fixed interest sector does have merits, I would be wary of being overly exposed and would look to perhaps be more creative with the types of exposure, rather than simply buying conventional gilts or bond funds.”
Scrivens says that advisers and wealth managers holding significant weightings in fixed income assets within cautious portfolios is unlikely to correlate with their clients’ ability to stomach downside risk.
“This worries me as they’re going into these asset classes which could potentially get trashed when interest rates do start to creep up,” he warned.
“If you can go to somewhere where you’re going to get a safe 3 or 4 per cent, why would you go and get something in bonds or fixed interest that gives you 2 or 3 per cent?”
“There is definitely increased risk there, but of course the question is: where else do you put the money as a conservative or moderate investor in today’s investment landscape?”
