Easing the shift to equities

The widely expected great rotation from fixed income to equities will be sped up by the end of the US quantitative easing programme, and early indications suggest mixed market reaction.

Aside from the hype, what evidence suggests a 'great rotation' is sending assets back to equity markets?

Ben Bernanke's June statements about reducing the monthly US$85 billion quantitative easing programme in the US sent markets into a tailspin. The Dow Jones Industrial Average dropped 2.3% on the day of the announcement, which led to similar activity globally.

Although a move to equities is widely expected, so far the effect on both asset classes has been similar. Data from the Investment Company Institute for Q2 showed total fund inflows for all asset classes for the quarter until 19 June hit US$32 billion, with June dropping half the flows gathered in April and May. Although performance was poor across asset classes, bonds were hardest hit, and registered a quarterly negative flow of US$1.8 billion as of June 19.

In a quarterly research note published last week, Bernstein Research summed the much-discussed impact of QE curtailing for asset managers, in which it said investors had chosen to de-risk from both equity and fixed-income products ahead of any concrete action by the Fed.

What will happen to liquidity in equity markets in the short- and long-term?

One surprise the Bernstein Research paper noted was the rise in US equity exchange-traded funds (ETFs), which captured US$5 billion of inflows in June, largely in SPY-based funds. This suggests despite investors looking to de-risk away from equity and fixed-income, ETFs may continue to experience a bump in liquidity over the short-term.

For asset managers with high levels of fixed-income assets under management, the short-term outlook is not wholly positive. The Fed's tapering of QE will inevitably lead to less activity in these instruments in the short-term as the market prepares to adapt to the post-QE world. A longer-term outlook does suggest equities will experience a consistent boost.

Will the expected 'great rotation' lead to lower trading costs for equities?

If indeed assets are moved across to equities from fixed income instruments, the upshot for equities trading will be manifold.

A boost in liquidity will buoy equity markets after a prolonged period of low volumes, and undo some of the damage of the financial crisis. But, apart from this liquidity rush, trading costs for buy-side participants will likely remain the same. For sell-side firms, however, the undesired reality of recent years brought about by reduced commissions against fixed trading costs will being to favour brokers as volumes rise.

Longer-term flow-on effects from higher volumes may give rise to reduced trading fees as exchanges and alternative venues seek to attract participants to trade equities. The timing could give a particular boost to new venues not yet launched, such as former Chi-X Europe CEO Alasdair Haynes' Aquis Exchange and MarketBourse - a Europe-based venue that will operate on the principles underlying social media. Higher volumes may reduce buy-side concerns about trying these new equity trading venues.