Fund managers scramble to track market reversal

Everything has changed. Since mid-April, asset prices across a number of markets have dramatically altered. Broadly, everything that was going up now seems to be going down - and vice versa.

The shifting sands between bonds, equities, currencies and commodities has prompted some fund managers to reverse strategy and investment tactics.

This includes addressing the sell-off in both equities and government bonds, the rebound in the euro after it came close to parity with the dollar, a renewed appetite for cyclical stocks over defensives and the strengthening of the oil price in a reversal of a trend that has dominated the markets since last summer.

"A lot of correlations are changing with trillions of dollars moving around," says James Sym, a European equity fund manager at Schroders. "Interpreting the changes in this market will define the success or failure for some fund managers over the coming months."

In just a few weeks, large scale bets that had prospered for some time, driven largely by the European Central Bank announcing and launching quantitative easing during the first quarter, have backfired, sparking a comprehensive scramble among investors.

At one investment committee meeting late last month, portfolio managers at a big European asset management group changed positions in a range of trades as they grappled with the sea change in the market place.

Mike Amey, a senior bond fund manager at Pimco, says: "In essence, the market has been hit by the ECB [European Central Bank] unwind. The German Bund market has sold off, the euro is strengthening and peripheral spreads against Germany have widened."

Other fund managers say the ECB unwind is a decisive turning point for the market. It has been billed by some as the end of the ECB quantitative easing trade after the central bank's €1.1tn bond-buying programme pushed yields to record lows in mid-April and at its peak saw more than $3tn of bonds trading with negative yields.

Certainly, it has meant one of the biggest shifts in portfolio weightings for a long time, particularly in the government bond markets.

For example, German Bunds, which largely led the market moves, have experienced a spectacular jump in yields since the middle of April. German 10-year yields, which have an inverse relationship with prices, have risen from a low of 0.05 per cent to a recent intraday peak of 0.80 per cent.

With inflation expectations rising and deflation fears no longer dogging the market, managers are trimming positions in Bunds, particularly with the US Federal Reserve expected to increase rates for the first time in a decade at some point later this year.

"Some investors will have been caught on the wrong side of the Bund trade,'' says John Stopford, co-head of multi assets at Investec Asset Management. ''They will be less inclined to hold such aggressive positions in Bunds again."

For this reason, he does not expect the benchmark Bund yield will return to its mid-April low.

Mr Amey agrees and advises switching cash into corporate bonds. Since the world economy is expected to grow and default rates fall, he backs buying both investment grade and high yield bonds.

In equities, Germany's Dax has dropped more than 5 per cent since the middle of April as a strengthening euro has hurt exporters and helped trigger a pullback in a market that was propelled to record highs above 12,000 a few weeks ago.

Mr Sym recommends cyclical stocks in sectors such as banking and insurance because they are relatively cheap and says it is time to scale down positions in the more expensive defensives, such as Nestle and Unilever, which have long been in vogue because they are bond-like and safe but at the same time deliver higher yields.

Finally, the oil price is likely to influence moves in other assets.

Michael Hulme, a commodity fund manager at Carmignac Gestion, says oil should provide some stability and trade around the $70 a barrel level. He does not expect it to drop back to the lows of around $50 at the start of the year. If he is right, oil should have a calming influence on other markets.

However, after the recent volatility, few investors are prepared to make bold predictions. "Some investors are still very overweight cash," says Mr Stopford. "Until we know when the Fed will move, that might make sense for the cautious investor."

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