Who’s driving the equity rally?
Does the money match the story?
Perhaps the biggest investment theme of the year so far has been the extent to which long-term investors may now slowly migrate back to under-owned and under-priced equities from super-expensive safe haven bunkers such as ‘core’ government bonds, yen, Swiss francs etc to which they herded at each new gale of the 5-year-old credit storm.
Indeed, some go further and say asset allocation mixes of the big institutional pension and insurance funds are – for a variety of regulatory and demographic reasons – now at such historical extremes in favour of bonds that they may now need rethinking in what some dub The Great Rotation.
All this has played into a new year whoosh in equity and other risk markets, as ebbing tail risks from the euro zone, US budget and China combine with signs of a decent cyclical turn in the world economy into 2013. Wall St’s S&P500, for example, has climbed 5.5% in January so far and closed above 1500 for the first time in more than five years last week following its longest winning streak (8-days) in eight years.
But what sort of money is behind this price move? Well, new cash flowing into equity funds so far this year has been the highest on record at some $55 billion. Retail investors have certainly been big participants, with Lipper data showing new-year retail inflows to U.S.-based stock funds at their highest since 2001. HSBC points out that 9 consecutive weeks of net retail buying of equities is “longer and larger” that any of the sporadic bursts seen over the past two years and emerging market equity appears to be a clear favourite.
But what of the bigger behemoths?
An HSBC analysis on global fund holdings (based on data provided by fund tracker EPFR) reckons big international funds are far less pessimistic than they were six months but are still broadly neutral on equity overall. “We measure this by tracking the holdings of high and low beta sectors and it is now only marginally in favour of low beta sectors”
And despite a big recovery in European bank stocks in tandem with an easing of the euro crisis, it reckoned international institutional funds remained underweight the sector. HSBC added:
By being underweight an outperforming sector they have to buy to stand still. This explains why the underweight remains large even though there has been plenty of buying.
The report goes on to show that institutional investors are positioned very cautiously in the US, with the biggest overweight in the underpeforming healthcare sector.
There remains potential “fuel” for further upgrading relative to benchmarks at least.
Yet what of the more conservative defined-benefit pension funds or insurance funds being pressured by liability-matching pressures and stricter mandates or guidelines? Regardless a possible Great Rotation over the next decade or so, how are these funds likely to behave shorter term?
Credit Suisse points out some market speculation that funds traditionally balanced evenly between equity and bonds may tend to rebalance portfolios at fixed intervals and so may be forced to return funds to neutral by selling equity at the end of a month that saw a big outperformance of stocks over bonds.
The potential size of this shift in the United States is eye-opening — at some $92 billion worth, according to CS.
Yet it downplayed the fear of some mass mechanical movement, highlighting three broad categories of behaviour among such fund managers — those who rebalance daily and will already have smoothed out positioned; those who do so at fixed periods such as month-end or quarter-end; and those who have significant discretion on timing and positioning within a broad remit.
We estimate that Private Defined Benefit Pension plans would need to reallocate about $34 billion, State and Local Pension Plans about $44 billion, and “Hybrid” mutual funds about $14 billion, for a total of about $92 billion – which we know is much higher than what is likely to be seen given the number of managers who rebalance more frequently or have discretion.
Month-end price histories over the past four years also show this to have had only a limited market impact, CS said. That said, it does tally somewhat with the early month surge turning flatter into this week.
But this is mechanistic behaviour should be fleeting by definition. Changes in how fund mandates and remits change over time is a far bigger issue and that will likely also take much longer to parse on aggregate.