Investment banks should be given more credit for their marketing genius. Goldman Sachs invented the term “BRIC” in 2001 and this developed into a fully fledged organization. More recently, last October, Bank of America Merrill Lynch came up with the term the “Great Rotation” and now this is taking over global investment dialogue.
The actual title of the Bank of America Merrill Lynch paper which coined the Great Rotation spells out the message clearly enough: it was titled “The Bond Era Ends”. With yields so low around the developed world, it makes sense investors must be chasing higher returns elsewhere. And there is evidence that is happening, but not as much, or as quickly, as you might think.
AXA Investment Managers has produced a detailed paper on the Great Rotation in its “Investment Acumen” series. Several authors have tackled the topic from different angles including the institutional perspective, market conditions, cycles, the fixed income/equity alternative focus, real estate and re-risking a portfolio. The conclusion is: it is not happening, yet.
Tim Gardener, the former Mercer head of investments in London who heads up institutional client strategy at AXA IM, sums it up: “The perception that somehow a change in the perceptions of the relative risk/reward equation between bonds and equities will lead to massive cashflows from one to the other is a good headline for the popular press but hopelessly simplistic”.
Gardener says it is tempting to say that no institutional investor would engage in a rotation trade. “Most are on a journey and have learnt either by their own experience or the experience of others that allowing their strategies to be swung about by short-term perceptions of relative market prices is to enter a game in which they have no competitive advantage. To the extent that the long-term investor has to invest or disinvest money, then a view on markets may be helpful or, indeed, necessary but this is at the margins.”
Gardener adds, however, that the value of dynamic asset allocation is now acknowledged by most and therefore the speed with which institutional investors follow their journey plan may be impacted by relative market prices.
It should be remembered, though, that Gardener lives in the UK where the defined benefit funds dominate thought about pension fund strategies.
Mathieu L’hoir, equity strategist, says there are two types of rotation: trade rotation, where an opportunistic move is made through a TAA adjustment; and a great rotation, which is a big shift in strategic long-term asset allocation. The great rotation would be connected to long-term risk budgeting, the regulatory environment, monetary policy and liquidity.
He points out that pension fund allocations to equities declined in most countries between 2001 and 2011 and are at historical lows. Only in Australia and Norway, in the cohort studied, did the allocation to shares increase in that period.
AXA IM’s view is that current market movements and associated investor portfolio rebalancing fall into the trade rotation (tactical) category.
“Indeed we believe that the prevailing risk/return profile of equities and bonds and the risk-bearing flexibility and capacity of insurance companies and pension funds are not fully supportive of a great rotation, at least not yet.”
Australia and Norway, the outliers in asset allocation over the 10-year period referred to, may present an interesting case study in years to come. Australia has had a high allocation to equities since Award super was introduced in the 1980s. But given the nature of the Australian system this is to be expected.
In the aftermath of the global financial crisis, Australia was shielded from the worst in Europe and the US by the resources boom. Now, for the first time in many years, we are facing a genuinely low interest rate market. It may not be a great rotation in Australia either, but there’s enough evidence to suggest there is certainly some rotating action, if not to equities then at least to “growthier” assets than bonds.