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Why should you change your asset allocation?

In the past two quarters, only one asset class has undergone a significant change in popularity. That is emerging market debt, or emerging market corporate bonds to be specific.

Emerging market debt

Demand for EM corporate debt has been on the up this year, as the asset class is benefiting from enduring dollar weakness. All major emerging market currencies, except the Argentinian peso, have risen against the greenback this year. This has boosted the asset class, as the bulk of EM bonds are denominated in dollars.

Three in 10 European fund buyers are now planning to increase their exposure to the asset class, a 50% rise since March. Over the past few months, European investors have already stepped up their allocations to emerging market bonds. According to Morningstar data, cumulative inflows into the asset class until July amount to €42.4bn, with the bulk of the money going to blended funds, investing in both government and corporate bonds across emerging markets.

Emerging market corporate bonds was the only asset class to record a change in net sentiment (% of buyers – % of sellers) of more than 10 percentage points over the past two quarters. Appetite for all other asset classes has remained remarkably stable.

Lack of trading

This calmness is reflected in conversations we’ve had with fund buyers and portfolio managers. Most have made only minor tweaks to their portfolios this year, with many saying they can’t recall a year with so little trading activity as 2017. This lack of trading seems not just confined to the world of fund buyers: Citibank warned on 11 September that third-quarter trading revenue would be down 15% year-on-year. The US bank blamed the persistently low market volatility for the fall in revenue, as this has been a disincentive for investors to trade.

European equities

A lack of change in asset allocation preferences means the asset classes that were popular at the beginning of the year have retained their attraction. Back in March, half of Europe’s fund buyers were planning to increase exposure to European equities. Emmanuel Macron’s victory in France’s presidential elections has since boosted the asset class, which saw its rise then stopped in its tracks by a strengthening euro. All this hasn’t affected appetite (see chart), and money has been flowing into European equity funds since spring at a steady pace: average net monthly inflows exceeded €5bn between April and July.

Absolute return

Since ‘nothing has changed’, absolute return retains second place in our quarterly asset class popularity contest. Despite the record-low volatility and the seeming absence of imminent threats to the eight-year long bull market, absolute return funds have continued to see steady inflows this year.

Of all absolute return sub-categories, long/short equity funds remain most in demand. Long/short equity funds have recovered from a woeful 2016, again delivering steady, albeit unexciting, returns. A third of survey respondents plan to increase their allocation over the next 12 months. This number has, almost inevitably, stayed roughly the same since March.

Emerging market equities

Emerging market equities also remain popular with European investors. The outlook for the asset class has brightened after a few uncertain months following Donald Trump’s election to the US presidency. A lack of concrete protectionist measures by the US administration, a weakening dollar and the positive momentum for global economic growth have spurred emerging equity markets to new highs. Consequently, net inflows have recovered, with EM equity funds seeing an average of more than €2bn in net inflows per month since the start of the year.

Roughly four in 10 survey respondents plan to increase exposure further over the next 12 months, while the number of those intending to sell continues to hover around historic lows.

While index trackers have captured the bulk of new inflows into European equities, active managers remain dominant in emerging markets. And they may have Donald Trump to thank for that. According to Tim Love, EM investment director at GAM, Trump’s explosive tweets about certain emerging market countries have often moved markets, providing fresh opportunities for active managers.

This article was first published in the October edition of the Expert Investor magazine.

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