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cycle comes full circle

What does research gathered by Expert Investor Europe in 2012 suggest about the prospects for a great rotation in 2013? By Will Jackson



BofA Merrill Lynch Global Research says its fund manager survey shows that professional investors are poised to slash their fixed income allocations and start buying higher-beta stocks. Other commentators have gone further and say a rotation is not just likely – it is already underway.

European investors have certainly displayed greater appetite for equities since the fourth quarter of 2012, as demonstrated by sales data from the European Fund and Asset Management Association (see bar chart). Yet a sustained bond sell-off has failed to materialise over the same period, and yields on highly-rated government debt remain at historically low levels. So what does research gathered by Expert Investor Europe in 2012 suggest about the prospects for a great rotation in 2013?

Our analysts visited professional fund selectors in Barcelona, Brussels, Helsinki, Oslo and Stockholm during the third and fourth quarters, asking investors if they expected to increase, reduce or maintain their allocations to a range of asset classes. Interviewees were largely upbeat on stocks and downbeat on developed world government debt. But their continued appetite for corporate and emerging market bonds indicates that a full-scale rotation may be some way off.

European equities

A key trend in the second half of last year was the return of demand for European stocks. Barcelona-based fund selectors are particularly bullish on this asset class, with two-thirds of our interviewees planning to increase their allocations, owing to what they perceive as cheap valuations (see ‘European equities’ graph). A similar proportion of Finnish investors expect to bolster their European equity weightings, with interviewees most enthused by opportunities among blue-chips and locally-domiciled companies.

Norwegian fund selectors are also likely to focus on stocks listed on their home market, while Belgian interviewees plan to skew their European allocations towards value strategies.

Only Swedish investors plan in aggregate to reduce their European equity weightings. None of the Stockholm-based pension schemes and banks our analyst visited in December expect to increase their exposure to the asset class – marking a sharp deterioration in sentiment since our February 2012 survey, when one-third of respondents planned to bolster their weightings to the continent. Interviewees worry in particular that krona appreciation against the euro has damaged the prospects of local exporters, and they favour US and emerging market stocks instead. 

EM stocks

Indeed, the developing world is the only region in which all interviewee groups plan to bolster their equity weightings (see ‘Global EM equities’ graph).

Finnish fund selectors display the greatest appetite for emerging market stocks, owing to what they perceive as attractive demographics and valuations. While the majority of Helsinki pension schemes, private banks and wealth managers our analyst consulted use global strategies to access the asset class, they are most upbeat on the outlook for Asian companies.

Belgian fund selectors are similarly bullish on Asia but also prefer to outsource country allocation decisions to global emerging market managers (despite their view that fees on GEM funds are too high). Spanish investors are interested in Indian and Chinese equities specifically, as well as those listed in Brazil – a market that also appeals to Norwegian fund selectors. Oslo-based interviewees say Brazilian miners are an attractive diversifier for their domestic oil sector exposure.

Government bonds

Emerging markets are also in demand when it comes to government debt. All of our interviewee groups are bearish on the outlook for developed world sovereign bonds (see ‘Developed market govt bonds’ graph), thanks to the historically-low yields on such securities.

The safe haven status, and consequent ultra-low sovereign bond yields, of many Nordic nations means that fund selectors in these countries achieve particularly little value by holding securities issued by their own governments. Only Spanish investors express some appetite for domestic debt.

In contrast, developing world government bonds remain highly attractive for many interviewees, including a staggering 90% of Swedes – the most positive response on this asset class from any EIE survey during 2012 (see ‘EM govt bonds’ graph below).

Stockholm-based fund selectors say they expect to increase their exposure this year via a blend of hard and local currency strategies. Finnish investors are additionally keen to explore higher-yielding ‘frontier market’ sovereign debt.

High yield

High yield products dominated European fund sales tables in 2012, as the Morningstar Other Bond sector – a grouping of hedged high yield, flexible and target maturity strategies – reigned supreme, pulling in €44bn. Our research indicates appetite for this asset class is likely to continue. Finnish fund selectors are most bullish on the riskier end of the corporate bond market, while two-fifths of Swedish investors also plan to bolster their weightings, in anticipation of 6% to 7% returns this year.

However, the exuberance that surrounded the asset class in 2012 may be waning. For example, Belgian investors express concerns that lower-quality corporate debt has become over-priced.

Investment grade

Turning to investment grade, almost four-fifths of Norwegian fund selectors expect to increase their exposure to highly-rated corporate securities (see ‘Corporate bonds’ graph). Because of perceived exchange rate risk and a generally upbeat stance on their domestic economy, Oslo-based interviewees view domestic investments as particularly attractive. They consequently favour locally-issued corporate bonds.

While other groups are not as enthused by the asset class, they also plan to increase their exposure. As with high yield, Belgian fund selectors no longer view investment grade as attractively-valued.

Absolute return

Away from equities and bonds, absolute return funds appear likely to remain popular in 2013, according to EIE research. All of our interview groups expect in aggregate to increase their exposure to such strategies. Swedes display the greatest appetite, with more than two-thirds planning larger allocations. Finnish fund selectors additionally express an interest in traditional Asia-focused hedge funds, run by managers based either in Hong Kong or Singapore.