The great rotation theory never took off. Fixed income mutual funds attracted $286bn of net new money from investors globally last year, far outstripping the $220bn of flows into equity-focused equivalents.
That trend has been reinforced so far this year, with global bond funds drawing $153bn of new money in the first four months of 2015, according to figures from Morningstar, the data provider. Equity funds, by contrast, have attracted just $43bn over the same period.
There are signs, however, that investors may be about to change tack on stocks as their search for returns in the low interest rate environment intensifies.
Create, the asset management consultancy, researched the asset allocation preferences of 705 institutional investors, including pension funds, sovereign wealth funds, asset managers and investment consultants with combined assets of $27tn, in the first four months of 2015.
The findings bode well for active and passive equity fund managers. A third of the respondents said they expect investors to increase their exposure to equities significantly over the next three years, compared with just 16 per cent who disagreed.
Amin Rajan, chief executive of Create, says: “To be risk averse is the biggest risk [investors] face. Investing in an era of negative real yields is like driving a car backwards. [Quantitative easing] has pushed all investor groups up the risk curve — whether they like it or not.”
Investors believe this shift will be particularly prevalent among defined benefit pension schemes, which are struggling with the punishing combination of rising liabilities, rising deficits and rising negative cash flows.
Defined contribution pension plans and retail investors are also expected to take on more risk through higher equity exposure. Mr Rajan says: “Prudence has held that retirees or near-retirees should be overweight in bonds and not take risks with their retirement nest eggs. The prospect of ultra-low yields for the foreseeable future is sidelining this age-old wisdom. In search of yield, investors are now forced to act contrarian.”
More than two-thirds of investors, expect current equity valuations to be sustained, despite the fact that several equity indices have hit all-time highs this year.
Nearly half (47 per cent) of investors also believe there will be a rotation from bonds into equities, potentially reversing the trend that has taken hold since 2006.
The scarring experience of the financial crisis led US pension schemes to cut their equity exposure from 69 per cent in 2006 to 50 per cent in 2014. A similar shift has taken place in the UK, where pension funds have reduced equity exposure from 58 per cent to 40 per cent.
Alain Kerneis, head of client solutions strategy at BlackRock, the world’s biggest fund house, says that this year most pension funds and insurance companies have demonstrated greater “risk aversion through higher cash levels and outflows from equities”.
Nonetheless, he believes pension funds will increase their exposure to stock markets in an attempt to improve their funding levels. In the UK, the average pension scheme has a funding level of 84 per cent, down from 100 per cent in January 2014, according to the figures from the Pension Protection Fund, the lifeboat for capsized corporate pension schemes. The funding levels of Dutch pension funds have similarly been dropping from 112 per cent in June 2014 to 103 per cent at the end of March, according to the Dutch National Bank.
“[Pension schemes] are underfunded so they need returns to go back to a more conservative level, which is why they are willing to add more to equities,” says Mr Kerneis.
Jim McCaughan, chief executive of Principal Global Investors, which commissioned the Create report, takes comfort from these results.
“The past few years have been characterised by some pretty wild swings in the market in terms of attitudes to equities. The phrase ‘the lost decade’ was quite widely used,” he says. “I am not really surprised [by the apparent change in sentiment] — I am somewhat relieved.”
Optimism about continued growth in corporate earnings — particularly in the US, Japan and India — is tempered by the expectation of increased volatility in markets, particularly as the US Federal Reserve moves closer to raising interest rates.
About 63 per cent of investors are concerned about volatility, in the awareness that markets have fallen 30 per cent or more at least once a decade on average since 1830, according to Create.
The single biggest worry for the vast majority (90 per cent) of the 100 senior fund management executives interviewed after the survey was conducted was the normalisation of interest rates in the US.
Rate rises are expected to reduce equity valuations globally, as well as raise the cost of servicing the $9tn of dollar-denominated debt issued by governments and companies outside the US, primarily in emerging Asia.
Mr Rajan highlights another kernel of potential good news for the active fund manager community. He believes that quantitative easing in the US, Europe and Japan has “overly inflated equity markets, lifting the good, the bad and the ugly”.
“When the tide goes out, as it surely will one day, we shall see a huge dispersion in the returns of individual components of widely used indices. Stock picking will be at a premium when valuations start returning to their ‘fair value’.”
Dylan Ball, global equity fund manager at Franklin Templeton, the US asset manager, is hopeful that the dismal performance of the vast majority of active fund managers last year will prove to be a blip, and that the normalisation of interest rates will enable good stock pickers to outperform.
He says: “Last year was the worst year on record in terms of active performance. In Europe, 80 per cent of active managers underperformed. It is a statistical aberration. [It is possible that] QE is not a good environment for stock pickers and when interest rates rise, stock picking will become a profitable strategy.”
Mike O’Brien, co-head of solutions at US fund house JPMorgan Asset Management, agrees: “The distinguishing economic trend of the past 30 years has been a steady decline in interest rates, and as that begins to reverse, we may find it creates a fertile ground for stock pickers”, he says.
Active management: The bonfire of the equities
Active fund managers suffered one of their worst years on record in terms of investment performance last year.
About 55 per cent of actively managed equity funds in the UK underperformed their benchmark in 2014, according to S&P Dow Jones, the index provider. This marked a significant deterioration on 2013, when just one in 10 funds in this category underperformed.
The majority of actively managed US equity funds (84 per cent), global equity funds (85 per cent) and emerging market equity funds (63 per cent) also trailed their benchmarks.
The research team at S&P Dow Jones found little to excuse the poor performance.
Commenting on the findings, it said: “Overall, markets were volatile in 2014. Volatile markets are considered to be fertile ground for active fund managers as they could utilise their stockpicking skills to benefit from the perceived discrepancies in the market. [Our data] suggest that active fund managers struggled to do so last year.”
The performance figures have put further pressure on the industry, which has been widely accused of failing to provide value for money to investors.
These fears have helped drive the growth of cheaper, passive funds sold by the likes of Vanguard and BlackRock.
The exchange traded fund industry expanded by 36 per cent last year after attracting $338bn of net new assets, surpassing the $272bn record for inflows set in 2008.