History tells us extended bull markets make investors nervous – and even the most experienced investors sometimes get the timing wrong, writes Principal Global Investors’ Grant Forster.
Wait too long and the market falls (along with your portfolio), but get out too early and you risk missing out on stellar returns.
Comments from influential analysts about the death of the ‘cult of equities’ in 2012, for example, saw investors flock into fixed income at inflated valuations, only to discover too late that they had missed the ensuing rally in equities.
This year’s CREATE-Research Report, commissioned by Principal Financial Group, focuses on precisely this issue.
The report distils the views of over 700 pension plans, sovereign wealth funds, asset managers and fund buyers with total assets under management of USD$26.8 trillion globally.
Taking the most recent bull run in equity markets as its starting point, the report asks the question at the heart of the worldwide debate into the future of equity investment: are we in a period of remission, or better still, revival?
And what does this mean for advisers and their clients? How should we assess the notion of equity risk premium in an environment of artificially suppressed interest rates, and which asset classes are likely to be favoured by high-net-worth (HNW) investors and retail investors?
As ever, there are competing views. Some hold that the easy monetary policies of the world’s central banks are at the heart of the recent rally, and that valuations are running ahead of underlying value drivers; whereas others see more fundamental support for current market levels and are more optimistic about future prospects for equities.
There were two headline findings in the CREATE-Research Report.
Most investors are driven by pragmatism
While up to two-thirds of respondents remain favourably disposed to equities, they are pragmatic and hard-nosed in their attitude.
Only 28 per cent expect equities to have a secular re-rating, despite the strong bull-run since 2009, and the reason is simple.
Over 70 per cent of respondents believe that investors chase returns not asset classes, and are therefore pragmatic about doing whatever works in a surreal world of near-zero interest rates.
Perhaps the reality of the current equity revival will be best judged not by the inflows when markets are rising, but by their resilience when the inevitable correction comes.
The ‘bondification’ of equities will gain traction
Investors understand that in the current low growth, low interest rate environment, being too risk averse is the biggest risk of all.
On one hand, returns from all asset classes are likely to be lower than in the past, but on the other, if equities continue to perform, and investors stay out, they will pay a heavy price.
Most will continue to focus on stocks with good dividends, less debt, strong pricing power, good free cash flow and a high return on equity.
In other words, equities that they hope will perform like bonds, but with a growth upside.
What does this mean for advisers with retail and high-net-worth investor clients?
Responses from the report indicated that both segments remained favourable to equities.
However, when allocating assets, each drew a distinction between opportunistic portfolio rebalancing in the short term, and asset allocation for extracting value premia in the medium term.
As one interviewee said, "the old-style strategic asset allocation does not work when assets are so mispriced and risks so obscure”.
Overall, HNW investors showed a keen interest in uncorrelated absolute returns, and the top three asset classes most likely to be chosen for short-term opportunism were exchange-traded funds (49 per cent), commodity funds (43 per cent) and currency funds (41 per cent).
When it came to medium-term asset allocation, real estate (63 per cent) was most popular, followed by actively managed equities and/or bonds (56 per cent) and private equity (55 per cent).
The hunt for yield is reflected in asset allocation choices which, according to 50 per cent of interviewees, will centre on newly emerging vehicles such as funds with an income focus and multi-asset class funds, both favouring quality equities.
When it came to regional nuances for asset allocation in the medium term, North American retail investors favoured traditional passive bonds/equity funds (64 per cent), whereas retail investors in Asia (excluding Japan, but including Australia) are more likely to focus on actively managed equities and bonds.
The situation in Australia
Australia’s superannuation system stands out globally. Defined contribution superannuation funds account for around 85 per cent of total pension assets, compared with only 58 per cent in the US and 29 per cent in the UK.
At the same time, there is a surprising lack of products in which retirees can invest their super savings.
Equity funds are far and away the most popular choice, and investors have also shown a distinct preference for domestic equities.
At present, Australian investors’ preference for domestic equities has made most portfolios very overweight domestic banks, and this strategy has paid off over the long run as the banks have delivered consistent dividend yield off the back of profitable mortgage businesses.
This preference has underperformed global equity over the last five years on both the hedged and unhedged basis.
The fall in the Australian dollar over the last 12 months highlights the need for diversification. The report did point to two emerging risks, however.
This first is concentration risk, as the world economy in general and the Chinese economy in particular slows, potentially driving volatility in Australian equity markets.
The second risk lies in the sequence of returns. If lower returns are experienced in the early years of retirement, overall returns will be lower.
In the end, the bottom line, as always, is that no investor has a crystal ball – and no amount of analysis can guarantee investment outcomes.
What does seem clear is that equities remain a preference for investors as they confront a new, ultra-low yield landscape and take a supremely pragmatic approach.
Or as one interviewee put it: “Investing in an era of negative yields is like learning to drive a car backwards. There are no precedents.”
Grant Forster is the chief executive of Principal Global Investors (Australia).