(March 8, 2012) — Equities will have long-term return benefits for most investors despite the asset class underperforming bonds over the past 15 years, Wellington Management concludes in a newly released report.
In recent years, individual and institutional investors globally have lowered their allocation to equities in favor of fixed-income for many reasons, such as reducing the volatility in their portfolios. While the embrace of a fixed-income heavy liability-driven investing (LDI) strategy is logical for corporate pensions, the majority of investors still need substantial returns and portfolio growth to meet their long-term objectives.
The Wellington paper asks: “Where will the necessary returns come from?”
“A near-perfect environment for Treasuries over the last 10-plus years has resulted in strong bond returns, significantly lower equity allocations, and historically low yields,” the paper co-authored by Conor McCarthy and James Rullo asserts. “At the same time, most investors’ return goals remain high.”
Ultimately, the authors concluded that they believe that investors should base strategic asset allocation decisions on fundamentals and valuations, rather than on recent returns. While allocations to other areas of fixed-income or to alternative asset classes may be appropriate, there are often limits to their use, such as liquidity constraints and the skill required to select and monitor complex strategies. Thus, the paper asserts: “We believe that current market conditions and historical capital market behavior suggest that now is a good time for investors to examine their fixed income and equity allocations to determine if they have the appropriate exposure to equities to meet their long-term objectives.”
The paper by Wellington follows a similarly supportive paper on equities by UBS Global Asset Management, which concluded that the stage is set for investors who pursue US equities to deliver active returns. Amid heightened market volatility — agitated by the eurozone’s worsening state — the paper urged investors to keep active. “Active investment managers are typically hired to take positions that differ from the market with the aim of adding value by exploiting inefficiencies. Dispersion of security returns is a basic measure of available opportunity and is related to the concept of breadth, which, coupled with skill, enables a manager to generate value,” the paper said. Ultimately, the authors conclude that managers who take bigger active risks stand a better chance of winning compared to ‘closet indexers.’
Additionally, the UBS paper explained that the market has resulted in a flight to perceived safety, creating additional opportunities for active investors. “The flight to safety and elevated level of market volatility have pushed valuation spreads back to very high levels…The good news is that a very high level of valuation spreads is an excellent forward-looking indicator of stock selection opportunities,” the paper said.