UNDERMINING THE CULT OF EQUITY
By Jonathan Gregson
As alternative investments become mainstream and returns diminish, the traditional bias toward equity investment is being challenged like never before.
Even before globalization became a major theme, big investors had a thoroughly international outlook. Capital moved rapidly around the world, seeking either safety or the best return on risk. As market indexes rose through the spring of 1987, there was much talk of the "wall of money" coming out of Japan.
The intervening years have seen the scale and speed of global capital flows grow exponentially. Investment infrastructure has changed beyond recognition. New money destinations have emerged, as previously closed markets in Eastern Europe, Asia and Latin America have become more investor-friendly. The range of asset classes acceptable to nonspecialist investors now embraces commodities, derivatives and private equity.
Even the goalposts have changed, with the switch from classic portfolio theory toward the more ambitious—and less forgiving—principle of maximizing absolute returns. "One of the clear trends over the past 15 years," says Pars Purewal, UK asset management leader at PwC, "is the move by investors from traditional equities and bonds towards alternative investments." That is borne out by rapid hedge fund growth , private equity, real estate and other alternative investments' share of total funds invested, which has risen from below 3% in 2000 to roughly 10% today.
Since 2008, volatile market conditions have seen a shift in investors' priorities from the stellar outperformance (and proportionately high management and performance-related fees) achieved during the Great Moderation—the period of reduced business cycle volatility that occurred in the last two decades of the 20th century—toward "consistency of long-term returns."
Whereas the market corrections of 1987 and the 1990s did little to dent investor enthusiasm for equities, the bursting of the dot-com bubble in 2000 undermined the cult of equity. US public pension funds have reduced their allocation to equities from 70% just 10 years ago to 52% now, over which period real returns on equities have been 1.8% compared with 6.1% for bonds.
The eurozone crisis triggered a flight to safety, says Sreekala Kochugovindan of Barclays' Global Asset Allocation Strategy Research. Consequently, several asset classes once considered risk-free—including many asset-backed securities and Southern European sovereign debt—have fallen from grace. Thus, the availability of safe assets has shrunk from $30 trillion to just over $12 trillion, resulting in a "safe-assets squeeze."
Looking further out, SWFs and large family offices in the Middle East, Eastern Europe and the Far East will play a larger role, and investment may gravitate toward new destinations in Asia, South America and Africa.