It’s always worth scanning the data on fund flows, if only because they give us an accurate record of what bets institutional investors are currently taking with their clients’ money.
The big story at the fund level is one of mismatch between two clashing narratives.
One narrative is that equity markets have bounced back aggressively and that we are potentially facing a lesser spotted melt up.
The contrasting narrative is that at the funds level, investors have been withdrawing money from equity funds and reinvesting in bond funds. Latest numbers from the Lipper team at Refinitiv reinforce the latter narrative – March, for instance, was the eleventh consecutive month with net outflows from long-term mutual funds after 16 consecutive months with net inflows. The Lipper team reports that Bond funds (+€16.4 bn) were the bestselling individual asset type overall for March, with the Bond Global USD hedged (+€3.5 bn) sector, the bestselling sector among long-term funds that month.
So, what’s going on? I reckon there’s a two-step process at work that might help explain those fund flows. The first is that institutional investors pump money into longer duration bond funds as they chase the yield down (courtesy of the Fed capping interest rate rises) and then take profits and switch back into equities as the global economy slows picks up speed again, post a possible China-US tariff deal at some point this summer. So, run with profits on equities but also make money from chasing that long-term yield down.
This makes short term tactical sense, but what’s going on inside most big institutions long term asset allocation strategies? We can get some hints of an answer via Natixis which has just run a deeper dive on institutional fund preferences amongst 200 global fund buyers – responsible for selecting funds included on private bank, insurance, fund-of-fund and other retail platforms.
Their conclusions? The big one is that active fund management is back in business. “Three-quarters of respondents agree that alpha is becoming increasingly difficult to obtain as markets become more efficient, and they are willing to pay higher fees for potential outperformance and agree that the 2019 market environment is likely to be favorable for active portfolio management.”
I’m not sure that bet on active fund management is a sensible one but I’ll park that argument for another day.
Another interesting observation is that amongst the survey respondents, the long-term rate of return assumptions for diversified portfolios has declined to an average of 7.7%, down from 8.4% in 2018. Given how long bond yields are, this would suggest that most institutions will need to buy back into equities to hit their returns assumptions – confirmed by the Natixis report which observes that there is a bias “towards risk assets prevailing”, although fund buyers intend to trim their overall equity allocation by 1.2 percentage points to 43% (down from 44% in 2018). Digging down into equity asset classes, U.S. equity allocations are likely to fall, while emerging market exposure is likely to increase.
“ Just under half (44%) of fund buyers say they plan to decrease their allocation to U.S equities, with opinions evenly balanced towards European equities. A significant portion (39%) of fund buyers indicated that they plan to increase their allocation to emerging market equities in 2019”.
The Snake Oil Pitch
One last observation. Private equity and alternatives. It’s nice to see Warren Buffett this week taking a shot at the performance data reported by private equity funds. He’s quite rightly suspicious of the claims made by PE fund sellers which should act as something of a red flag to big institutions who seem to be betting aggressively on private business assets. Natixis confirms this preference for alternatives in their report – they observe that amongst their 200 survey respondents, most plan to increase weightings in alternatives (+19% in infrastructure, +15% in private debt; +17% in real estate) with 70.1% of overall alternative allocations being made into liquid assets.
Buffett is of course right. The returns from PE only look good because the numbers have been tortured enough. PE is a classic illiquidity play, fuelled by leverage and funds selling assets back and forth between each other. Come the next downturn, we can confidently expect another big portfolio valuation blow up.