A rapid shift of wealth to emerging markets and changes in pension fund asset allocation in the developed world are among a number of factors which will see a marked decline in the demand for equities in developed markets, potentially accelerating trends toward multi-asset dealing by institutional investors.
A recent report by consultants McKinsey anticipates a trend away from equities which will affect how companies are funded. Even though total investor demand for equities would grow by more than US$25 trillion over the next decade, in McKinsey’s base case scenario, the consultancy predicts this demand would not be sufficient to cover the amount of additional equity that corporations will need, leaving a potential US$12 trillion ‘equity gap’.
As more investors in mature economies enter retirement, they typically stop accumulating assets and begin to rely on investment income, shifting assets from equities to bank deposits and fixed-income instruments. “This pattern has led to predictions of an equity sell-off as the enormous baby boom generation in the US and Europe enters retirement,” the report said. “If investors retiring in the next ten years maintain the equity allocations of today’s retirees, equities will fall from 42% of US household portfolios to 40% in 2020 – and to 38% by 2030.”
In Europe, where aging is even more pronounced, McKinsey predicted an even larger shift in household portfolios.
European equity market turnover was down to €774 billion in October, steeply lower than September’s €899 billion. In October 2010, European equity market turnover stood at €729 billion.
Edinburgh-based investment house Kames Capital, formerly the asset management arm of Aegon UK, is one of a number of buy-side firms to have already adopted a multi-asset trading desk. “We have increased our skill set to the point that all members can trade multi-asset if needs be,” said Adrian Fitzpatrick, head of investment dealing. “You’re only as strong as the weakest link, so everyone has to be comfortable trading anything.”
In addition to ensuring traders have the necessary skills, Fitzpatrick has worked with the provider of Kames order management system to add multi-asset functionality and is increasing the firm’s use of multi-broker trading platforms in different asset classes.
Maturing tastes prefer income over growth
According to McKinsey, another factor influencing equity allocations was a shift to defined contribution retirement plans in Europe and rising allocations to alternative investments. “In Europe, defined contribution plan account owners allocate significantly less to equities than managers of defined benefit plans,” said the report. “As private pension funds close to new contributors, managers are shifting to fixed income instruments to meet remaining liabilities.”
Tom Stevenson, a London-based investment director at Fidelity, was not convinced a long-term trend away from equities could be construed from the popularity of income from fixed-income investments among aging populations. “That’s not the entire story,” he said. “People are also living longer, which means they will need to protect their assets from erosion, supporting their spending power against inflation. Growth assets such as equities would be an important piece this protection plan.”
And it was doubtful such a trend would drastically change portfolio manager’s ability to find liquidity, according to Stevenson. “If equities fell as a share of global assets, this might mean a smaller opportunity set at the margin, but it will still be sufficient for bottom-up houses such as Fidelity to find opportunities,” he said.
Jonathan Lipkin, head of research and pensions at the Investment Management Association, a UK buy-side trade body, said it was important investors had access to a diversified range of assets, including risk assets such as equities, particularly as demographic change puts an ever greater emphasis on funded pension provision.
“On the positive side, geographic diversification is already happening. Home bias has been eroding strongly in the UK over the past decade and global equity exposure is increasingly the norm in both direct benefit and defined contribution equity holdings,” said Lipkin.
Domination of Asian trends
McKinsey says the rapid accumulation of wealth and financial assets in emerging market economies is the most important cause of the perceived future equities gap.
Emerging market financial assets grew 16.6% annually in the past decade – nearly four times the rate in mature economies. “Depending on economic scenarios, we project emerging market financial assets will grow to between 30 and 36% of the global total in 2020,” McKinsey said.
Such growth would place emerging markets as an increasingly dominant force, but the consultancy noted that emerging market domestic investors still keep most of their assets in bank deposits. According to McKinsey, a key question will be the speed and extent to which such investors develop a larger appetite for equities and diversify their portfolios.
“Emerging market investors do have a preference for bank deposits rather than equities, but as an economy develops and its population becomes more affluent, equity investment increases,” said Fidelity’s Stevenson. “I suspect this will be the case over the long term, mitigating any possible decrease in equity demand in developed economies.”
Stevenson said the likely emergence of a two-speed world, where growth in the west slowed while the east continued to gain pace, could be an important factor for equity market liquidity in the medium term. “These types of trends will drive changes in where portfolio managers hunt for opportunities and liquidity,” he said.