The May 1 rebalancing of the Adviser Fund Indices saw 23 funds added to the indices for the first time and 21 removed. James Teasdale reports on the reasons behind the AFI panellists’ changes.Strong performance from global stockmarkets over the past six months has led many Adviser Fund Index panellists to make significant changes to their AFI portfolio recommendations. As reported in last week’s Fund Strategy (May 8, 2006, page 5, see Funds dropped as AFI panellists conduct portfolio rebalancing), almost 20% of Aggressive AFI constituent funds were removed by panellists at the May 1 rebalancing. The continued solid performance of all three indices has prompted many AFI panellists to take profits from funds or drop portfolios that have failed to impress. Paul Wynne, head of marketing and communication at Financial Express, says: “Although there have been quite subtle changes in asset allocations, the portfolios have experienced significant changes in constituents, indicating that fund selection is in play this season, with more changes occurring the more aggressive the portfolio.” Rebalancing of the three AFIs takes place every six months on May 1 and November 1, when the 18 AFI panellists have the opportunity to amend their portfolio recommendations. Up to 10 funds can be selected for each portfolio chosen from the UK unit trust and Oeic universe. Constituent fund weightings can also be changed at the rebalancing points and the portfolio recommendations of each panellist are aggregated to define the three indices. Paul Ilott, senior investment adviser at Bates Investment Services, says: “We have taken some risk off the table by capitalising on some higher growth areas where we have achieved significant returns over the past six months.” Regional exposure within Cautious portfolio recommendations has shifted, says Ilott. “We have taken a small amount out of the UK as we expect better growth prospects overseas,” he adds. Legg Mason US Equity was dropped from Bates’s recommendations and replaced with Baillie Gifford American. Ilott says: “We were a little disappointed with short-term performance from the Legg Mason fund and also wanted to tilt the portfolio more towards a growth style of management.” Allocation to specialist funds in the Aggressive portfolio recommendations has increased, says Ilott. Investec Global Energy was dropped, and Merrill Lynch Gold & General and Jupiter Emerging European Opportunities introduced. Five fund management groups excluded from the AFIs prior to the rebalancing are now represented following the panellists’ inclusion of JOHCM UK Equity Income, F&C UK Opportunities, Rathbone Income, Royal London Income and T Bailey Growth. Details of other funds added to the AFIs, together with notable funds dropped, are included in the boxes summarising changes to the three indices on pages 22 and 24. Brian Dennehy, managing director of Dennehy Weller, says: “In the Cautious index we have sold out of Invesco Perpetual Income and topped up on high-quality bonds. We have moved to more defensive holdings with the potential for an equity market correction in 2006. “We are concerned about the positioning of Invesco Perpetual Income. Neil Woodford’s fund has seen fantastic performance but with about 20% in tobacco stocks, this is a big bet.” Dennehy has also sold out of Invesco Perpetual Income in the Balanced AFI and replaced it with M&G Smaller Companies. “This is basically filling a gap as this sector was under-represented in what should be a balanced portfolio,” he says. With a reduction of the global emerging markets allocation in his Aggressive portfolio recommendations, Dennehy has also increased the weighting of the Jupiter Income fund. While panellists’ shifts in asset allocation were relatively minor following the rebalancing, overweight positions in European and global emerging market equities have generally increased, while exposure to North American equities has lowered across all three AFIs. Overall exposure to British shares has also increased slightly. Within domestic equity exposure, weightings to funds in the Investment Management Association UK All Companies sector have increased, while allocations to portfolios in the IMA UK Equity Income sector have reduced. Exposure to bonds has decreased in both the Aggressive AFI (from 6% at January 1, 2006, to 4% at May 1, 2006) and Cautious AFI (from 42% to 39%), but has increased slightly in the Balanced index (now 19%). The property and cash weightings of the three AFIs remain largely unchanged. Ian Shipway, director of investments at Thinc Destini, says: “We run a strategic process for our portfolios, with breakdowns of underlying asset classes based on long-term views, so we have not made any significant changes. We have rebalanced the portfolios by taking selected profits from areas that have done well. We have moved money out of emerging markets, Asia Pacific and Japan, and rebalanced across the other asset classes. There have been no significant changes in the actively managed funds we hold.” Shipway adds: “We also took the view that the Aggressive portfolio was probably more defensively positioned than it should be and upped the risk by tilting the portfolio to more of a growth bias.” Compared with the Association of Private Client Investment Managers and Stockbrokers indices, the much greater weighting to several overseas equity markets across all AFIs has increased returns markedly. The relative overweights of all AFIs to Asia Pacific, European and global emerging market equities, and underweights to British and North American shares, were successful asset allocation calls from the panellists. Average returns from funds in the IMA Global Emerging Markets (up 32.5%), Asia Pacific ex Japan (26.6%) and Europe ex UK (23.6%) sectors were all stronger than those in the UK All Companies (18.5%) and North America (8.2%) sectors. The average IMA Japan fund was up 18% over the same period. Both the Aggressive AFI (up 19.5%) and Balanced AFI (15.3%) comfortably outperformed the Apcims Growth (13.3%) and Apcims Balanced (11.7%) indices, while the Cautious AFI (10.1%) bettered the Apcims Income (8.8%) index by a smaller margin (see graphs below). Performance of each AFI was consistently better than the Apcims and average IMA Managed sector equivalents over the three, six and 12-month periods to May 8, 2006, according to Financial Express. While the top 20 best-represented groups across all AFIs have hardly changed (see table page 22), some groups have become more dominant, while others are not so prominent. With an increase in fund representation and weightings, Artemis is the best-represented group in the index, knocking Invesco Perpetual off the top spot. Jupiter and Merrill Lynch are among the other groups that have become more popular with the AFI panellists, while Schroders has dropped from fifth place to 11th. Of the groups outside the top 20, Resolution Asset Management (formerly Britannic) and Martin Currie have moved up significantly, while Henderson Global Investors and HSBC are among groups falling down the table. Of the 23 constituents that were not included in the previous AFI season, M&G (Smaller Companies and Strategic Corporate Bond), Merrill Lynch (European Dynamic and UK Absolute Alpha), Neptune (European Opportunities and Japan Opportunities) and New Star (Cautious Portfolio and UK Special Situations) all had two new funds added. Axa Framlington (Health and Nasdaq) and Fidelity (American and Special Situations) are the only groups to have two funds drop out of the AFI series. Chris Taylor manages Neptune Japan Opportunities. He says: “For the first time in 15 years Japan is positioned for a broad-based economic recovery. Companies have quietly got on with restructuring themselves, corporate profits are rising and money is coming back into the economy to replace fixed capital assets and fuel higher wages. “The markets were cheap compared with other OECD [Organisation for Economic Cooperation andDevelopment] markets and global asset allocators have spotted this. Last year small and mid-caps saw strong performance and it was natural for markets to take a breather. In 2006 the mega-caps have outperformed for the first time in years. On balance, we expect markets to do well for the rest of the year.” The fund holds about 40 stocks and is currently overweight capital goods manufacturers and financials. Stocks held include Skylark, a restaurant chain, and Monex Beans, an online broker. Another new entry to the Balanced and Cautious index is Jonathan Platt’s Royal London Income trust. The portfolio invests predominately in investment grade or equivalent credits, although it can take short-term tactical positions in government bonds. Platt says: “Compared with investment grade portfolios managed by our peers, the fund looks more widely at possible investment opportunities. About 15-20% is invested in bonds without an explicit credit rating, but having investment grade characteristics based on our credit research.” The fund’s biggest weighting is in financials, including British clearing bank debt. Platt is also bullish on insurance companies and investment trusts but bearish on utilities, consumer goods and industrials. Spreads on consumer and industrial bonds have continued to come in, while financials generally offer higher yields, he explains. The fund is currently overweight BBB-rated credits, with most activity centred around new issuance, says Platt. Clive Beagles’ JOHCM UK Equity Income fund was added to all three AFIs at the May 1 rebalancing. Financials made up 45.5% of the portfolio’s holdings at March 31, 2006, with a heavy weighting in banks (26%). The fund is also overweight the consumer sector. Beagles says: “The average UK investor has been negative on the consumer for some time. We are not so bearish and believe banks are more broad-based, with overseas exposure. Barclays, HBOS and Royal Bank of Scotland are trading on multiples of 10 to 11 times earnings, with yields of 4.5% to 5%. Trading is improving and mortgage approval data is reaching new highs. This tells us that life is not quite as bad as the average bearish UK commentator would have you think.” The portfolio is underweight commodities, with nothing held in oil and mining companies. Recent merger and acquisitions activity has helped boost fund returns. “By dealing in the value end of the market we have been lucky to catch a few bids, including BAA, BOC and Westbury,” says Beagles.l Performance of the Aggressive, Balanced and Cautious AFIsReturns from each of the above indices, income reinvested, from November 1, 2005, to April 28, 2006. Changes to the Aggressive AFI and underlying asset allocation
With 22 new constituents and 21 funds dropped by the AFI panellists, the Aggressive index saw the most turnover as a result of the rebalancing. Funds falling out of the index include Credit Suisse Income, Fidelity American and Axa Framlington’s Health and Nasdaq portfolios, none of which now appear on any of the AFIs. Of the 22 funds added to the Aggressive index (see table), M&G Smaller Companies and Neptune European Opportunities are among 16 funds that were not represented across any of the AFIs over the six months to May 1, 2006. The 21 constituents dropping out of the Aggressive AFI include 13 funds no longer appearing on any of the three indices. Of those current constituents present prior to the rebalancing, Fidelity European, Jupiter Financial Opportunities and Lazard UK Alpha saw their weightings increase the most (in percentage points) in the Aggressive AFI. Conversely, the panellists’ overall allocation to Artemis Income, First State Asia Pacific Leaders and Legg Mason US Equity fell the most at the rebalancing point. As at May 1, bonds only made up 4% of the Aggressive index, down from 6% at January 1, 2006. While just shy of 90% of the riskiest AFI was invested in equities prior to the rebalancing, approximately 92% of the index is now allocated to shares. The panellists’ clear preference for equities over any other asset class has been reinforced further by the rebalancing process. The proportion of equities allocated between domestic and overseas shares has hardly altered, with an almost exact 50/50 split. Of the international equities held, the panellists have chosen to increase holdings in Europe and global emerging markets, reduce allocation to North America and keep exposure to Asia Pacific companies at 14%. Artemis, Invesco Perpetual and Jupiter are the best-represented fund management groups in the Aggressive AFI, with a total of 19 funds appearing in the index. The Aggressive AFI now has 108 constituents. Changes to the Balanced AFI and underlying asset allocation
The number of constituents in the Balanced index stays at 103 funds, with the 18 adviser groups adding 17 new funds and dumping the same number. This represents 16.5% of funds in the index being replaced. Gartmore European Selected Opportunities, Investec Global Energy and Schroder European are among the funds ousted from the index, with none now represented in the AFI series. Funds joining the AFI series for the first time include JPMorgan US, Merrill Lynch UK Absolute Alpha and Newton Oriental. Of the 17 funds added (see table), 11 were not represented across the three indices in the previous AFI season. The biggest percentage point increases in weightings within the panellists’ Balanced index recommendations were allocated to Artemis European Growth, Jupiter Income and Merrill Lynch UK Special Situations. In contrast, the allocations to Cazenove UK Dynamic, Invesco Perpetual Income and Legg Mason US Equity were reduced by the most. The Balanced AFI is the only index where allocation to fixed interest has increased as a result of the rebalancing – from 18% at January 1, 2006, to 19% at May 1. Exposure to British equities increased, while allocation to overseas shares as a proportion of total equities held reduced to 36%. The panellists’ overall weighting to Asia Pacific equities fell from 10% to 7%. Artemis, Invesco Perpetual and New Star were the three fund management groups best represented in the Balanced AFI, with 17 funds appearing in the index. The Balanced AFI continued to outperform both the IMA Balanced Managed sector average and the Apcims Balanced index over the six months to April 28, 2006. However, the 15.3% return from the Balanced AFI was only marginally higher than the 15.2% achieved by the average IMA Balanced managed fund (see graph). Changes to the Cautious AFI and underlying asset allocation
Turnover of funds in the Cautious AFI was the lowest of the three indices – amounting to 12.7% of constituent funds. But with 13 of the 102 funds in the index being dumped by the panellists, the index still saw some significant changes. Funds dropping out of the AFI series include Anthony Bolton’s Fidelity Special Situations fund, Newton Income and Henderson Preference & Bond. New entrants to the Cautious index, and AFI series as a whole, include Liontrust First Growth, New Star Cautious Portfolio and Standard Life UK Property. Of the 13 funds dropped from the index, nine no longer appear in any of the AFIs, while nine of the 14 constituents added were not represented across the three indices in the six months to May 1, 2006. Artemis European Growth, Framlington UK Select Opportunities and Jupiter Income are the three constituents seeing the largest percentage point rises in their allocations within the Cautious index. Funds faring poorly, with large reductions in weighting, include Artemis Income, Invesco Perpetual Corporate Bond and Standard Life Select Income. The three best-represented groups in the Cautious index, by weighting and number of funds included, are Artemis, Jupiter and Standard Life. The number of constituent funds in the Cautious index rose by one to 103 following the rebalancing changes. The asset allocation weightings of the lowest-risk AFI saw several notable changes. Allocation to British equities rose from 35.5% as at January 1, 2006, to 40% following the rebalancing. Just under one quarter of the panellists’ equity exposure in the Cautious AFI was invested in overseas shares as at May 1. Bond exposure fell from 42% to 39%. The Cautious AFI (up 10.2%) strongly outperformed both the average fund in the IMA Cautious Managed sector (up 8.4%) and the Apcims Income index (up 8.8%) over the previous AFI season (see graph).