Despite a multi-year bull run and sky-high valuations, equities will become the go-to asset class for most investors over the next few years, according to a new report.
The study, produced by UK-based researcher Create in association with Principal Global Investors (PGI), found over 70 per cent of the 705 international fund managers, pension funds and others it surveyed expected long-term investors to “return to equities in large numbers over the next three years”.
“Respondents base this assessment on three expectations,” the Create report says.
The study, titled ‘Pragmatism Presides, Equities and Opportunism Rise’, found just under 70 per cent of those surveyed expected the move to equities would be underpinned by current prices holding up and valuations to “reconnect with their drivers”. Almost 50 per cent of respondents also picked there would be “a rotation from bonds to equities”.
Grant Forster, head of PGI Australia, said the degree of investor support for equities was “a little surprising” given the current high market valuations globally. But Forster said ongoing unorthodox central bank monetary policies and improving fundamentals in some markets did explain the broad investor confidence in shares.
“It’s not a dumb faith in equities,” he said. “Investors know there will also be market corrections but they expect to be able to trade through them.”
The Create study attributes the global resurgence in demand for shares – including parts of Europe and Asia where the ‘cult of equities’ has not traditionally been strong – to “an agnostic search for decent returns”.
“On balance, for most investors, the price of staying in equities is only exceeded by the price of staying out,” the report says.
However, the study found investors expect the ‘equity risk premium’ (ERP) – defined as “the expected return of stocks in excess of a risk-free rate from bonds” – would remain high but volatile.
“ERP is high because bond yields are ultra-low,” the Create report says, with the majority of investors expecting volatility if interest rates normalise.
“The second salient point that emerged from our interviews was whether it is advisable to put too much faith in ERP as a predictive tool, according to some 55% of participants,” the study says. “This is because the traditional notion of risk-free assets no longer holds.”
Forster said the Create report also highlights the ‘bondification’ effect on certain equities globally as fixed income yields remain at historic lows.
The study says bondification will see yield-seeking investors focusing on equities with “good dividends, less debt, strong pricing power, free cash flow and a high return on equity”.
“We’re used to that mentality in the Australian market where retail investors tend to treat banks stocks as bonds,” he said. “But bondification is happening offshore too. Investors are expecting bond-like returns out of equities.
“They will be wrong to expect that.”
Investors will target absolute returns from equities and bonds and tilt portfolios more towards real assets such as property, the report says.
The annual Create report is based on a survey of over 700 investment managers, pension funds, sovereign wealth funds and consultants in 29 jurisdictions, who collectively represent almost US$27 trillion in assets.