Volatility fosters defensive stance

Panellists adopted a defensive position in the latest Cautious index rebalancing, with a fall in allocations to financials, basic materials and corporate bonds - and a rise in cash weightings.

The rebalancing of the FE Adviser Fund Index (AFI) Cautious index in November shows a series of defensive allocation moves following a volatile period for equities. Asset allocations show that panellists allocated away from equities, property and fixed interest, and increased their allocation to cash.

Weightings towards British equities in the Cautious index lost one percentage point twice in 2011, in both the May and November rebalancing of the index, taking the allocation down to 23%. Similarly North American equities and other international equities both lost 1%, dropping to 5% and 3% respectively. Allocations to property, European equities, Asia/Pacific equities, and structured products all remained unchanged during November’s rebalancing. Meanwhile, allocations to ’unknown’ assets climbed four percentage points to 12%. Cash weightings rose from 5% to 7%.

The sector breakdown displays a similarly cautious consensus. Sectors that lost weightings are, perhaps, the obvious candidates for the chop in anticipation of a bear market. Financials, industrials, and basic materials all lost one percentage point each. (AFI continues below)

The financial sector, burdened by troubled banks in Britain and throughout Europe, could be seen as a riskier proposition. Industrials and basic materials are reliant on construction, and with limited output at home and commentators hinting at a slowdown in China, investors may be reluctant to risk their capital.

The biggest loser in the sector breakdown was corporate bonds, which lost seven percentage points at the latest rebalancing, reducing its weighting to 18%. Over the longer term the sector’s popularity appears unstable. In May’s rebalancing, it gained eight percentage points, while across 2010 as a whole it lost 13 percentage points of allocations.

Meanwhile, ’other fixed interest’ gained four percentage points. FE AFI panellists see this as evidence that investors have become cautious. “My immediate take is that there has been a sharp de-risking of the portfolio,” says Tim Cockerill, the head of collectives research at Rowan Dartington. “It is interesting that investors have chosen government debt [over corporate bonds]. The question that people are asking is: where do you go to put money?”

The more ambiguous sectors also profited from the latest rebalancing with “Other” gaining one percentage point and “Unknown” picking up an additional three percentage points.

Analysing the geographical breakdown, panellists allocated two percentage points each to Australasia, International, and cash. Oddly, one percentage point was also allocated to Europe excluding UK despite the continuing troubles in the eurozone. After May’s rebalancing, European allocations were at a historically low level of just 8%, so the weighting has risen from a low base.

Allocations to the Pacific basin dropped by two percentage points from 3% to 1%. Britain, North America and Other all lost one percentage point, while Japan and Asia Pacific remained static at 1% each.

Cockerill’s pick of a suitable fund for cautious investors in this environment is the M&G Corporate Bond fund. This appears to match the consensus of the panel: not only was M&G the most popular provider in the Balanced index in November’s rebalancing, but it is also the top provider in the Cautious index as well, with L&G in second place.

“M&G is inherently conservative,” Cockerill says. “They have a clear macro view, and over the past few years they have been pretty accurate. They also stick to their views, and this is a key strength.”

M&G’s placing in the Cautious index is owed predominantly to the same two funds that ranked highly in the Balanced index: the M&G Optimal Income and M&G Property Portfolio funds. In order, the top five funds chosen by the panel were: M&G Optimal Income; L&G Dynamic Bond; Artemis Income; M&G Property Portfolio; and Newton Global Higher Income.

The top five constituents by performance and their total returns from May 1, 2007, to May 1, 2010, were; Investec Emerging Markets Debt, returning 87.06%; GLG Global Corporate Bond, which rose 81.21%; BlackRock Gold & General, up 72.79%; Aberdeen Emerging Markets, rising 69.84%; and Old Mutual Global Strategic Bond, gaining 56.91%.