All good things must come to an end and there is growing concern among global fund managers that the recent run of good fortune from equity markets is starting to wane.
The Bank of America Merrill Lynch fund manager survey for April 2015 reports the highest instances of fear for valuations since 2000.
A net 25 per cent of the 177 respondents to the global survey believe global equities are currently overvalued, up from a net 23 per cent in March and a net 8 per cent in February.
The catalyst for the gloomier outlook comes from the US where rates are expected to rise, leading to 66 per cent of respondents calling US stocks overvalued.
In the UK, too, the disruption that follows a general election has further driven concern about the equity markets.
Bill O’Neill, head of the UK investment office at UBS Wealth Management, says: “Consumer confidence often weakens after an election and domestic interest rate rises are on the horizon… [The Conservatives’] proposal for an EU referendum is likely to go ahead in 2017, posing uncertainty about the future role of the UK in the EU and implications for UK companies with cross-border trade.”
Global equities have enjoyed strong performance – with a couple of notable hiccups – since 2008.
Tim Giles, partner in Aon Hewitt’s investment practice, says his universe of active global equity managers has delivered between 7.5 per cent and 15 per cent over the past five years.
Consumer confidence often weakens after an election and domestic interest rate rises are on the horizon
Bill O’Neill, UBS Wealth Management
It is this strong performance – and historically low bond yields – that has gone some way to tempering the decline in UK defined benefit scheme allocations to the asset class.
According to the 2014 Mercer European asset allocation survey, between 2008 and 2013 UK pension plans reduced equity exposure by a consistent 4 percentage points a year.
Yet in 2014 the Mercer survey showed a 2 percentage-point reduction in equity allocations.
In some cases, pension funds still grappling with an astronomical deficit have held back on asset-liability matching exercises, taking advantage of the global equity outperformance and waiting for bond yields to rise.
Atul Shinh, investment specialist at Investec Asset Management, says: “The challenge that a lot of schemes have is their sizeable deficit, and they need growth assets to reduce that. Global equities will be the key driver of pension fund returns over the long term.”
Indeed, equities still make up 37 per cent of UK pension funds’ strategic asset allocation, according to the Mercer survey, of which 25 percentage points are in non-domestic stocks.
However, while Shinh says global equities remain the driving force for pension fund investors in closing funding gaps, there is no escaping the overall shift away from these growth assets.
The Mercer survey shows 25 per cent of European pension funds will decrease global equity holdings, while just 9 per cent plan to increase them in the next year.
Dylan Ball, portfolio manager for global equities at value manager Franklin Templeton, blames the UK’s legislative regime for driving pension funds away from equities at a time when they should be investing to help plug funding gaps.
“It is regulation that drives [UK institutional investors’] investment decisions, unfortunately. The regulator is always regulating to the last crisis; it is telling institutional clients to derisk and move ivnto bonds and to match off all your liabilities, and don’t take any risk. But if you want to close deficits, you’ve got to take some risk,” Ball says.
But just as the DB supply to global equities begins to dwindle, defined contribution schemes are fast becoming the more important provider of lifeblood to the world’s stock markets.
Towers Watson’s 2015 global asset allocation survey predicts DC assets will overtake DB assets within the next few years, which will see investor demand swing back towards growth assets, notably global equities.
And a 2014 survey of DC default funds offered by the UK’s FTSE companies, undertaken by asset manager Schroders, found 49 per cent of assets were invested in non-domestic equities.
Routes to access
In the new DC-dominated world, and indeed one in which DB investors are more aware of risk, the way in which pension pots access equity exposure is shifting.
For example, smart beta strategies are gaining traction with both DB and DC investors looking to manage volatility and keep costs down.
Jane Wadia, global head of client portfolio management at Axa Rosenberg, says: “We have seen fewer searches in the UK pension space for active [management] which is driven by derisking and governance issues. That has led to the rise of smart beta strategies.”
At the same time, Investec’s Shinh says multi-asset funds are taking some market share from pure global equity funds.
It is difficult to call the end of the equity market and if you are a long-term investor it still looks good
Tim Giles, Aon Hewitt
“We have seen a move into multi-asset funds where investors can get returns not too dissimilar to equities over the long term but with less volatility,” Shinh says.
And given the fear that is beginning to creep into global equity markets, investor appetite could continue to increase for less volatile investment vehicles.
The market outlook is uncertain for global equities, but this is not enough to cause consultants to suggest schemes move away from the asset class.
Aon Hewitt’s Giles says: “The valuations are pushing high on equities, but valuations of low-risk assets are high too. It is difficult to call the end of the equity market and if you are a long-term investor it still looks good.”
Gill Wadsworth is a freelance journalist
