The FTSE 100 soared over the winter, yet many wealth managers stayed loyal to bonds, missing out on the upturn. Freddy Barker finds out why the Great Rotation has bond-buyers in a bind
The FTSE 100 soared over the winter, yet many wealth managers stayed loyal to bonds, missing out on the upturn. Freddy Barker finds out why the Great Rotation has bond-buyers in a bind
THE FTSE 100 reached a five-year high of 6,500 in March on the back of its strongest annual start in a generation. Yet, surprisingly, many HNWs aren’t celebrating. Despite chatter of a Great Rotation out of bonds and into equities, many wealth managers stuck to bonds during the 15 per cent FTSE rise and thus missed out on a sizeable slice of the profits available to their wealthy clients.
It is suggestive that, as Ed Moisson at Lipper says, bond funds in Europe swelled 11.5 per cent in Q4 2012, and, further, that the trend continued into January 2013 with €20 billion more inflows.
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Sceptics will retort that you can’t dissect mutual fund data into investor type so it’s not guaranteed that private-client wealth managers failed to buy equities. But Graham Harrison at Asset Risk Consultants, the chief wealth-management benchmarking service, supports the thesis. ‘Analysing investment returns of the 49 private-client houses signed up to the Private Client Indices, London’s wealth-management community was not operating an overweight equity position during October, November, December and January,’ he says.
The situation is summed up by Merrill Lynch calling the February edition of its European Fund Manager Survey ‘Long on optimism, short on conviction’. Surveying 251 panellists with $691 billion in funds under management, the bank concluded that portfolio managers were cautiously optimistic but that their positioning remained close to neutral.
HOW SHOULD HNWs respond? On the one hand, their wealth managers have underperformed the winter FTSE rise and, moreover, they’ve underperformed their benchmarks since 2009. For example, FTSE APCIMS Balanced, a typical benchmark used by wealth managers, was up 23 per cent in the three years to December 2012; the average private-client portfolio was up 17 per cent, primarily on account of not having held enough longer-dated gilts.
While many would regard that 6 per cent spread as a sackable offence, there are mitigating factors. First, only the bravest of the brave overweighted equities in Q4 2012, three months that started with Hurricane Sandy inflicting the first weather-related stock-market shutdown since the great blizzard of 1888, and didn’t improve given persistent newsflashes about the Euro debt crisis and the US fiscal cliff.
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Second, wealth managers have performed much better over the cycle than they have over the past few years. For example, in 2008, top-quartile private-client managers in ARC’s Steady Growth index held losses to under 15 per cent whereas the FTSE APCIMS Balanced index fell by 18 per cent.
‘The divergence in perceived and actual performance,’ says Harrison, ‘is because wealth managers underperform indices in the early stages of rallies such as 2009 and 2012, which we’ve had more of recently, and outperform in downturns like 2008 and 2011, which we’ve had less of recently. They do so because they understand that private clients don’t like losses, so they manage money with one eye on benchmarks and the other on absolute returns, all the time attempting to smooth returns over the cycle.’
SO, SINS FORGIVEN, where are we now? The wealth-management industry has come a long way since 2012, when the standard position was underweight equity, neutral bonds and overweight cash.
After six months of putting more risk into portfolios, wealth managers are now at their most bullish since 2007. For example, a sentiment survey by Asset Risk Consultants recently revealed that 80 per cent of the industry is positive on equities, 12 per cent is indifferent and 8 per cent is opposed; in contrast, a whopping 50 per cent is negative on cash and bonds.
The outlook is thus glowing for HNWs — so long as global equity markets continue to rise. The S&P 500 is just 1 per cent off its all-time high, however, so that is no small statement.
Cheer comes in the knowledge that although stock markets are close to their records set in 2000, they are in fact 40 per cent cheaper, as corporate earnings have grown 80 per cent in the meantime. Moreover, the FTSE winter increase was the result of cash and money market funds being converted into equities; therefore, if bonds start to be exchanged too, a faster rise could yet transpire.
THE GREAT ROTATION argument, first espoused by Michael Hartnett at BofA Merrill Lynch Global Research in October 2012, is rooted in the fact that interest rates and bond prices operate like a seesaw: when one rises, the other falls.
Therefore, the fact that interest rates are currently 0 per cent means that they can fall no further and, conversely, that bond prices can increase no further. As a result, equities look increasingly appealing. And the good news is that green shoots are appearing in the economy: Alex Godwin at Citi Private Bank says: ‘Data has been steadily improving in the US, with capital good orders showing signs of reflecting increased spending by corporates. In China we have seen data reflect improving growth, too. And in Europe, although data is patchy, adjustments seem to be happening in wage levels that are feeding through into better export competitiveness.’
Johannes Jooste at Merrill Lynch Wealth Management supports the stance, saying that he’s seeing a great rotation within businesses: ‘They are putting cash piles to work through investment or acquiring other companies; the re-gearing of corporate balance sheets may lead to higher earnings-per-share forecasts, driving prices higher and giving an additional catalyst for equity buying.’
No surprise, then, that market movements at the time of writing in March were characterised by investors looking beyond government debt and into emerging market debt, high yield and structured credit, as well as higher beta stocks. Assuming the trend continues, it’s fair to question whether the FTSE 100 will exceed 7,000 in 2013, as the Telegraph recently reported Goldman Sachs predicting.
‘If it is possible to put aside the ongoing crisis in Europe,’ says Robert Farago at Schroders Private Bank, ‘there are no obvious barriers to further equity market gains. Valuations are not stretched. Prospects for global growth have improved. Liquidity remains ample, and corporate profitability is close to record highs.
‘This could be taken as a note of caution,’ he continues, ‘since it will revert to a lower mean at some point. However, for now, there is no pressure on wages due to high levels of unemployment and ongoing efficiency gains through increased use of technology.’
The most obvious threat to Goldman’s prediction, therefore, is that sentiment has become too positive, as technical indicators are warning. There is still plenty to worry about. In particular, it remains difficult to see how government debt levels will be brought down to sustainable levels on an orderly basis, and four years of excessively low interest rates should not be taken as a positive either. Both are signs that the recovery is built on unstable foundations.
It’s clear that while the Great Rotation is making wealth managers’ heads spin, their focus should remain on advising HNWs how market movements could impact their portfolios. If they communicate these well, then history proves that performance of all types can be tolerated.
