Fidelity’s WealthBuilder MPS offering has exited its position in US mid-cap equities to add to larger US value companies, in the view that mid-sized businesses have become more sensitive to rising borrowing costs.
The MPS range built a position in US mid-caps earlier this year to participate in the broadening of US growth beyond the largest technology names.
While this trade has performed well as investors looked for opportunities outside of the stocks at the centre of the AI revolution, the investment case has been weakened more recently by rising bond yields.
Caroline Shaw, co-portfolio manager of Fidelity WealthBuilder MPS, explained: "Mid-sized businesses tend to be more sensitive to borrowing costs, so we have exited the position and recycled some of the proceeds into larger US value companies, which we believe should be more resilient to any further rises in yields.
"Overall, we have brought our equity positioning closer to neutral while retaining exposure to areas where we continue to find attractive opportunities."
Equity markets and government bond yields moved higher together over the summer, a combination Shaw labelled “unusual” given the S&P 500 has reached new highs on resilient corporate earnings, while yields in some cases have hit levels not seen for many years.
The manager attributed the rise in yields partly to growing bond issuance.
"Government borrowing remains high across a number of developed economies, while large technology companies are also becoming significant bond issuers as they finance the enormous capital expenditure associated with AI,” Shaw said.
“That extra supply is one reason we believe upward pressure on longer-term yields could persist."
Shaw said how yields rise matters as much as the level they reach: a sudden spike in borrowing costs could unsettle equity markets quickly, whereas this year's rise had been more gradual, giving investors time to look past higher yields towards corporate earnings that remained healthy.
This gradual pace helped explain why equities and bonds had moved in a seemingly unsynchronised way, she added.
"However, the calm in equity markets at higher yields is unlikely to last forever. Higher borrowing costs eventually feed into mortgages, corporate financing, investment and consumer spending. If yields remain elevated, they are likely to exert a greater drag on economic activity and risky asset prices," the manager said.
"We have therefore taken some risk off the table following strong performance this year and have become more selective about where we take equity risk."
Within emerging markets, the MPS has taken profits following "particularly strong returns", reducing exposure to the technology-heavy weightings of Korea and Taiwan.
Shaw said the team continues to prefer "more differentiated opportunities" including Latin America, while India and China remain of interest where domestic fundamentals and valuations are supportive.
Within fixed income, the Fidelity WealthBuilder MPS range has reduced its exposure to emerging market debt and increased its allocation to high yield. Shaw said high yield companies currently benefit from relatively healthy credit fundamentals and starting yields of around 7%, while the asset class's shorter duration should make it less vulnerable to rising government bond yields than many traditional fixed income exposures.
The range has also added to its gold position. Shaw said this is a hedge against risks linked to elevated government borrowing and to bonds becoming a less reliable source of inflation protection. Commodities, industrial metals and absolute return strategies within alternatives have been retained.
Shaw concluded: "Growth and earnings remain supportive, so we do not believe this is the time to pivot strongly into more defensive areas. Time in the market remains important. But after a strong period for risk assets, rising yields present a new potential source of risk.
“We are taking profits where markets have run hard, reducing exposure to more interest-rate-sensitive areas and broadening the sources of resilience within portfolios. That leaves us able to participate if growth remains healthy, while being better prepared should the message coming from bond markets eventually begin to register more forcefully elsewhere."