Institutional Investors Cautiously Eye Return to Equities

Terry Flanagan

Despite ongoing eurozone fears and the impending ‘fiscal cliff’ in the U.S., some institutional investors are beginning to head back into equities.

In recent times, institutional investors have piled into less risky asset classes such as fixed income, which has been in a bull market for over 30 years now, while the more risky equity markets have been largely avoided.

“Free cash flow yields of companies are high, long-term growth characteristics are very attractive, the implied forward risk premium relative to debt is extravagant and in that environment if we can find the right companies with the right growth characteristics I see equities right now offering absolutely outstanding very long-term value,” James Bevan, chief investment officer of CCLA Investment Management, a U.K. fund manager, told Markets Media’s European Trading Investing Summit in London last week.

James Bevan, chief investment officer of CCLA Investment Management, speaking at last week's Markets Media conference in London

James Bevan, chief investment officer of CCLA Investment Management, speaking at last week’s Markets Media conference in London

Due to huge volatility in equity markets in the last couple of years as well as the clouded macroeconomic outlook, many buy-side investors have continued to steer clear of the asset class—despite the benchmark S&P 500 and FTSE 100 indexes both showing big year-to-date gains on either side of the Atlantic—but this could be about to change.

Improving economic sentiment, especially emanating from the U.S., is beginning to see some investors change their long-term view on equities.

According to a new BofA Merrill Lynch survey of fund managers this month, a net 20% of investors believe the global economy will strengthen in the next year, a rise of three percentage points month-on-month. While a net 24% of asset allocators are now overweight equities, up from a net 15% in September.

Two months ago, the gap in popularity between U.S. and European equities was substantial—but now the two regions are viewed equally in the eyes of allocators, according to the BofA Merrill Lynch survey, which polled 269 panelists with a combined $734 billion of assets under management.

“The outlook for European equities is improving, eurozone fears are receding and appear largely priced into equity risk premia; core government bonds offer negative real yields so the impetus to rotate into stocks in Europe, as the outlook stabilizes, is profound,” said John Bilton, European investment strategist at BofA Merrill Lynch Global Research.

The only clouds on the horizon appear to be that the impending U.S. fiscal cliff—the simultaneous expiry of tax breaks with the introduction of tax increases and spending cuts due at the end of this year, the cumulation of which could push the U.S. back into recession—is not properly factored into global equities and macroeconomic data.

The fiscal cliff is seen by 42% of respondents to the BofA Merrill Lynch survey as the number one tail risk event, up from just 35% in September, while the European Union sovereign debt risk is now seen as less of a threat with just 27% viewing it as the number one tail risk, down from 33% a month ago.

“While the U.S. fiscal cliff is a hurdle, growing belief in the global economy could spur a more ‘risk on’ stance from investors,” said Michael Hartnett, chief investment strategist at BofA Merrill Lynch Global Research.

Others, though, are not so sure.

“The challenge is, is this [macroeconomic turmoil] a short-term thing or a long term paradigm shift in economies?” Robert Gardner, founder and co-chief executive of Redington, an independent investment consultancy based in London, told the Markets Media conference last week.

“We’ve seen clients significantly outperform their liabilities with a super-low level of risk over the last few years, while others have got buffeted around by the markets. We will continue to see that bifurcation.”

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