As central banks attempt to exit unprecedented liquidity easing, we assess the potential impact on asset allocation trends, specifically whether we are about to see a rotation out of bonds and back into equities, as investors seek to re-risk.
Bonds to equities too simplistic
We think the concept of a great rotation hugely simplifies the nuanced demand dynamics. Based on our bottom-up assessment of investor segments, covering $89trn of assets, and the differing regulatory and demographic pressures on investor decision making, we conclude there are significant, and possibly underestimated, structural challenges to a rotation into equities.
We think two opposing rotations may be playing out simultaneously. Since January this year retail and high net worth investors have modestly reduced cash/near cash and increased risk assets. Global (equity and fixed income), income, and multi-asset products have been in particular demand. More recently, mutual fund flow data suggest a modest rotation out of fixed income and into equities, as confidence in economic growth has risen. This trend was even stronger for money market funds in mid-2013, suggesting shifts more readily here than into equities.
Against this, we see institutional investors (insurance and pension schemes) doing almost the opposite – despite the risks to fixed income portfolio values from a rising rate cycle. Insurers facing Solvency II regulations and DB pension schemes needing to immunize risks are still reducing their equity weightings.
Institutions neutral to equities
Institutional de-risking could outweigh much, if not all, of any increased equity appetite in retail. DB and DC schemes represent 45% of global equity investment, we estimate. Our analysis suggests this group will be a powerful headwind to any longer-term rotation back into equities, offsetting any cyclical re-risking from retail and HNW investors.
At best, institutional investors (60% of global AUM) are likely to be neutral for equity reallocations. We expect tactical de-risking and allocation shifts for US DB plans, the longer-term path of de-risking for the UK DB schemes, and regulatory constraints for insurers (Solvency II) to limit re-risking via equities. Sovereign wealth funds (7% of global AUM) are more likely to increase allocations to real assets and alternatives rather than to actively managed equity products.
Demographic changes dampen the appetite for equities among retail and HNW investors. Lower-risk appetite and ageing populations (by 2030, the 65+ age group in the US, Europe and Japan will have risen by 45%) are driving product shifts that inhibit strong rotation into equities.
Removing asset constraints will win out
Positive mutual fund flows so far this year are encouraging (1-3% for developed market equities after outflows every year since 2009), but we think the strong flows into asset allocation funds and ETFs suggest that, for traditional active equity product, the prospects of a great rotation are limited.
But if risk appetite picks up, it could translate into re-allocation from cash into risk assets. We think retail and HNW investors are more likely to chase market performance. Cash balances for private banking clients are still above longer-term averages.
We expect demand to increase for ETF, multi-asset solutions, unconstrained fixed income and alternatives. Our stock picks reflect our forecast for double-digit growth in multi-asset solutions, benefits to players able to offer unconstrained/alternative credit product or servicing the lower-cost end of the barbell, and best-of-breed alternative providers.
Globally, our top picks to play these themes are Blackstone, Apollo, Oaktree, BlackRock, and Schroders.
