John Ventre, head of multi-manager at Old Mutual Global Investors, examines the factors preventing a full-blown switch from fixed income to equities.
Core developed governments teeter on the brink of bankruptcy, but their bonds are more expensive than they have been in two hundred years.
Companies are engorged with cash, but share prices remain at modest levels, at best edging higher with only the most tentative steps.
Where is the rush to take advantage of this outstanding arbitrage? For many, the lack of rotation of investment assets out of fixed income and into equities is a real conundrum.
John Ventre examines the factors stopping a full-blown switch from fixed income to equities
Starting with the basics, there are several reasons why capital allocations are not always decided with return in mind:
• Demographic trends, such as ageing populations.
• The increasing focus by the regulator on matching investment with customer risk tolerance.
• Solvency II rules affecting the pension and insurance industry.
• The Volcker Rule as part of the Dodd-Frank Wall Street Reform and Consumer Protection Act.
• Bank stress tests and the ‘risk-free’ treatment of government bonds.
The baby boomers are rotating out of equities and into bonds
There was a substantial baby boom following the Second World War. In the developed world, using a retirement age of 65, these ‘boomers’ began to retire in 2010.
As investors approach retirement, they typically sell their riskier investments and seek annuities: in other words, they are sellers of equities and buyers of bonds. The retirement of this generation could have a meaningful effect on the balance of demand for equities versus bonds.
In the US, target-date investments are popular. These funds begin to sell equities systematically several years before retirement in order to do some dollar-cost averaging around what would otherwise be a major asset allocation change.
The obvious conclusion is that, although the baby boomers are just beginning to retire, they have been buying bonds already for some time and will continue to do so in larger and larger sizes as more approach that stage of their lives.
Given the lack of returns in bonds and lengthening life expectancy, we need solutions to allow this generation of investors to remain invested in retirement – but that is another story for another day.
The regulator requires that advisers focus on tolerance for loss
For clients, this is a positive development, as evidence suggests owning investments which exceed one’s risk tolerance forces them to make value-destructive asset allocation decisions at the worst time.
For example, buying equities in 1999 and selling them in 2003; buying equities again in 2006 and running for the hills in 2009.
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