Fund investors who have been sitting on large cash deposits are continuing to move back in to equities as their confidence in stock markets improves. But the flow from cash into equity funds is running contrary to direct shareholders’ behaviour – and the views of investment advisers.
Skandia’s most recent data on investment trends shows fund investors moving out of cash and money market funds, losing enthusiasm for corporate bond funds and simultaneously growing more keen on equities. Bond funds remained the top sellers in the third quarter, but almost two-thirds of “new” money was directed towards equity and managed funds in this period.
“This could indicate a returning confidence in the market as, although fixed- interest funds are still dominant, we see a lot more activity in more adventurous funds investing in other countries,” claims Graham Bentley, Skandia’s head of investment marketing.
Figures from the Investment Management Association offer more evidence of a flow from debt to equity. While corporate bond funds saw more inflows than other asset classes in August, these inflows are tapering off, falling from £535.3m in June to £338.3m.
By comparison, absolute return funds, North American equity funds and property funds gained favour in August. With £235.2m in inflows, absolute return funds were almost as popular as corporate bond funds. US equity funds and property funds reported £137.2m and £129.1m in sales respectively.
New research from the Association of Investment Companies (AIC), the industry trade group, suggests that a rapid recovery in confidence is the driving force. Confidence among active investors is at its highest for more than three years.
More than half (52 per cent) plan to increase their exposure to equities in the coming months, compared with just 33 per cent in September 2008. An an even higher proportion (62 per cent) of private investors expects equities to outperform property in the next year.
With shares in the average UK smaller companies fund up 42 per cent in the six months to the end of September, small caps have attracted attention. The Close Special Situations and Close Beacon funds were up 20.9 per cent and 15.5 per cent respectively last month, according to Hargreaves Lansdown.
Also on investors’ radar are blue-chip shares, natural resource companies, financial stocks, commodities and commercial property funds, which are benefiting from a pick-up in sentiment.
UK investors remain firmly loyal to their native markets, however, and the portfolios of 67 per cent of active investors are mainly invested in the UK. Emerging markets and Asia are the second and third most popular choices.
“Clearly, the recent market rally has helped active investors put the market turbulence of the last 12 months behind them,” says Annabel Brodie-Smith, an AIC spokeswoman. “Risk appetite is also on the rise, as tends to be the case during a market rally, and it will be interesting to see if this trend continues.”
However, some financial advisers have expressed concern about these fund flows.
Their fear is that shares are being bought too late in the current cycle, at a time when equity market price/earnings ratios are higher than historical averages, and when companies still face difficulty increasing their revenues.
“Is this a false dawn before a correction or have the economic fundamentals genuinely improved enough to engender a long-term stock market rise?” asks Ben Lundie, an investment adviser with Hargreaves Lansdown. “The jury is still out.”
Other advisers are actively encouraging fund investors to follow the lead of some direct shareholders, and take profits.
Tim Cockerill, head of research with the advisory firm Rowan, now warns against investing in emerging markets, following the 103 per cent rise in the MSCI emerging market index since the start of March, for example. Commodities also look expensive following a recent run-up in prices, so profit taking here is suitable, he says.
The appeal of absolute return funds, which are seeing a surge in interest, is that they offer some protection in a downturn. This is because they are able to take short positions as they fall under the European Union’s Ucits III directive, which gives mutual fund managers the power to use derivatives to generate positive returns in falling markets.
On the list of favoured absolute return funds are BlackRock’s UK Absolute Alpha fund as well as Gartmore’s UK Absolute and European Absolute funds, which are modelled on Gartmore’s successful hedge funds Alpha Gen Copella and Octanis. Rowan’s Cockerill is particularly keen on the Gartmore funds, but warns that they are not likely to be able to perform as well if markets are on the rise.
“Investors must appreciate that, if the market keeps rising strongly or recovers strongly from a setback, then this type of fund won’t keep pace with the market, as it isn’t designed to,” says Cockerill.
But Cockerill still argues that investors should prepare themselves for a setback in the near-term. “I”m not fearful of a total reversal because I do think the worst is behind us, but a correction of the FTSE 100 down to 4,500 or perhaps a little lower is quite possible,” he concludes.
