Investors need to hedge their equities risk
SAVVY investors should be moving into any asset class except equities – that’s at least according to Saltus Partners’ Jon Macintosh. Macintosh says that advanced economies’ stock markets are in for a period of downward or sideways movement, potentially for the next decade or more. He claims there’s only one scenario in which investors should stay in stocks: “If you’re confident your life expectancy is over 100 years, it’s safe to be in equities,” Macintosh says.
Because most exchange-traded funds (ETFs) are linked to equity benchmarks, this argument is one that should interest listed product investors in particular. The increasing proliferation of products that follow alternative indices does suggest that there is increasing demand for access to a wider range of asset classes that most investors were previously unable to access easily.
Research by iShares shows that since 2006, for example, assets under management (AUM) in European exchange-traded commodity products have risen from €2.5bn to €21bn to make up 12 per cent of all assets in exchange-traded products (ETP) in Europe, versus just 1 per cent five years ago. Meanwhile, hardly a month goes by without a raft of new currency products launched in Europe, with ETF Securities recently opening up 22 new currency ETPs to investors.
AN EQUITY PLATEAU
But should investors take advantage of the widening variety to get out of products pegged to developed market equity benchmarks? Both Macintosh and Cube Capital’s Francois Buclez point to certain periods over the past hundred years when equity growth has plateaued after a boom. These plateaus are not straight lines sideways, however, but periods of high risk and volatility during which the overall stock market fails to make sustained gains. Overall, equity markets have been in one such period since 2001 and the last such period, during the inflationary years of the 1970s, lasted over 15 years. Equities failed to deliver the capital gains that are currently associated with the asset class and both analysts think the current plateau will last.
Cerulli Associates’ Shiv Taneja disagrees, pointing out that 2008 was an extraordinarily rare period in history in that the global share of investments in equities dropped below 40 per cent. “It dropped to 35 per cent in 2008, but has bounced back in 2009 and 2010. And for all the focus on growth from emerging markets, the US and western Europe still account for over 80 per cent of global AUM and that’s not going to change any time soon,” says Taneja, who forecasts that equities’ share of global mutual fund investments will grow steadily in the coming years to reach 45.1 per cent in 2014.
But Taneja, too, sounds a note of caution about this growth: of the 16.2 per cent increase in AUM during 2009, 15.1 per cent stemmed from a stock market rally and only 1.1 per cent came from new net inflows. This means that although investors poured money back into equities, they were less comfortable about making the investments that might add to that equity growth in future.
DIVIDENDS WILL GROW
As an alternative to equities, investors could attempt to target distressed debt – which should deliver high returns given the amount of personal and business debt still to be unwound. There are few listed products that target this area directly, however. Traders could look at private equity index trackers – iShares’ S&P Listed Private Equity fund is up 24.33 per cent this year, while Powershares’ Global Listed Private Equity Portfolio has seen a 18.25 per cent return. Both ETFs are down since their inception, however, and relatively expensive – the iShares private equity ETF has a 0.75 per cent total expensive ratio, for example. Moreover, distressed debt is a risky area for many institutional investors trying to deliver consistent growth.
Another option is to consider dividend-trackers. Macintosh argues that as a counterpart to equities’ sluggish capital gains, it is likely that dividends will rise. Average dividend yields have been far below their historical average in the past ten years at under 2.5 per cent, whereas they should be significantly above government bond yields to compensate for equities’ comparatively risky outlook.
Even for those who don’t agree with the extreme thesis that developed market equity growth is “dead” for the time being, hedging one’s exposure to the major benchmarks is a good idea. Fortunately, with an ever-increasing range of ETFs available, tracking bonds is far from the only other way to make an index-linked investment.