The so-called “great rotation” back into equities from bonds is unlikely to be seen in 2013 among most defined benefit pension funds in major markets, including the U.S., U.K. and Netherlands.
However, institutions have taken their foot off the bond-buying pedal, as equities are outpacing government bonds from a relative valuation perspective, according to consultants, managers and plan executives. Also, investors are taking short-term tactical advantage of the rising equity premium by, for example, allowing multiasset managers to drift toward the higher end of the equity allocation range.
In addition, while many pension funds are moving out of investment-grade bonds, alternative asset classes, like hedge funds, real estate and private equity, are a more popular destination than traditional long-only equities.
“I don't think many people think that bonds represent screaming good value, but if you think equities represent relatively better value, the question is what do you do about it?” said Carl Hess, global head of investment consulting at Towers Watson & Co. in New York.
In the six months ended Jan. 31, the Russell 3000 index rose 11.23% compared with -0.29% for the Barclays Capital U.S. Aggregate Bond index. Worldwide, the MSCI All Country World index returned 13.74% during the same period, compared with a 0.68% gain for the Barclays Capital Global Aggregate Bond index. The long-term equity risk premium is typically between 4.5% and 5%.
Separately, the ratio between the earnings yield of the Standard & Poor's 500 index and 10-year U.S. Treasury bond yields reached 4.0 at the end of 2012, suggesting that the gap between the rate of return that stockholders require and that of bondholders has widened to unprecedented levels, according to data going back to Dec. 31, 1980 and compiled by Russell Investments. Between 1980 and 2002, the ratio rarely rose above 1.0 but has since been climbing.