Has the Great Rotation Begun? | Chief Investment Officer

Equity allocations are rising, and this time it is sustained – despite the prospect of the US Fiscal Cliff – are we entering the “Great Rotation”?

(November, 13, 2012) — The highest level of optimism in financial markets in almost two years has seen investors ploughing assets into equities, despite concern about the US Fiscal Cliff clouding the horizon, a survey has shown.

Over a third of investors responding to the monthly fund manager survey run by Bank of America Merrill Lynch said they believed the world economy would strengthen over the next 12 months. This 34% was the highest level of respondents showing such optimism since February 2011 and marked a 14 percentage point rise over the last month.

For the fifth successive month, investors have increased equity positions while selling off bonds. A net 35% reported being overweight equities, compared to a net 25% last month.

“Momentum has gathered behind the idea that we are on the cusp of a ‘great rotation’ out of bonds and into equities,” said Michael Hartnett, chief investment strategist at Bank of America Merrill Lynch Global Research. “The only missing ingredient is a resolution to the US fiscal cliff.”

For more stories like this, sign up for the CIO Alert newsletter. 

More than half of respondents to the survey thought the potential hit to the US economy was the biggest tail risk. This 54% number was up from 42% thinking the same last month.

However, a sign that investors are moving to a “risk-on” approach could be seen through a greater appetite for emerging markets. A net 37% of respondents were overweight in the sector’s equities this month, up from 32% in October. Investors also indicated they would take overweight Chinese equity positions in the short-term. Figures from Asia’s largest exporter this week showed the country’s output and growth prospects had recovered from a slowdown earlier in the year.

“While sentiment within Europe remains weak, rising allocations to global stocks tell us confidence in general is improving. The jump in China optimism shows how fast sentiment can turn around,” said John Bilton, European investment strategist at Bank of America Merrill Lynch.

Japan remained off the radar for most investors, however. Historic underweight positions were maintained by the panel of respondents and almost 40% predicting the yen will depreciate the most against a basket of major currencies.

Remember what happened when investors bought into products they didn’t understand? Well, it’s happening again – and a report by a fund management group suggests it might be their own fault.

(November 13, 2012) — Institutional investors are increasingly allocating to assets they do not understand – and the fault, according to at least some in fund management, could be their own.

A report from the Center for Applied Research (CAR), an affiliate of asset manager and custodian State Street, said investors were signing up for a wider selection of alternative assets in an effort to diversify portfolios and hunt for yield.

“On its face, the convergence of institutional investors into these asset classes seems healthy,” the report said. “As we dug deeper, however, we uncovered a troubling finding: Based on our investor interviews and survey work, we found that institutional investors aren’t fully prepared to handle the complexity that comes with alternative assets.”

However, the problems were being driven by the investors themselves, the report seemed to suggest.

Never miss a story — sign up for CIO newsletters to stay up-to-date on the latest institutional investment industry news. 

“Faced with growing uncertainty, many investors – both retail and institutional – are not acting in their own best interest,” the report said, “exhibiting behaviour that appears to be at odds with their stated goals.”

During the financial crisis, fund managers and other financial institutions were criticised for selling products to clients that they did not understand. The CAR report suggests this has continued rather than abated as many thought would – and should – be the case. The report entitled “The Influential Investor”, is light on detail about the sales and marketing tactics – or any change therein – by fund managers since the start of the crisis.

Investors, the report said, are being attracted to these diversifying assets due to concerns about the macro-economic environment, which has made it increasingly difficult to secure the returns needed to reach their liabilities.

The report continued: “By increasing allocations to alternatives, despite concerns that they aren’t prepared for the ensuing complexity, it seems that many institutional investors aren’t acting in their own best interest either.”

The CAR report showed investors considered this complexity as their major challenge in the immediate future, followed by demands from regulators and ratings agencies. However the same survey reported more than three quarters of this group as considering themselves as highly sophisticated in financial matters.

The report also criticised investment consultants and advisers for failing to adequately explain alternative assets and what they involved, to investors. It also cited a “bad faith” between investors and their providers, which was not helping them make the correct investment decisions.

“Only one-third of retail and institutional investors believed their primary investment provider is acting in their best interest. Investors reported that they do not receive sufficient financial education from their advisors,” the report said.

Fund managers were criticised by the report in one instance, however. CAR said the current method of performance measurement that used relative indices was not aligned to investors’ needs and that in future the industry would have to create a process of personal performance.

To read the full report, click here.