The consequences have been multiple and have taken place over two distinct periods. The first was one of euphoria, as all financial assets were repriced after the 2008 crisis. Even the eurozone's systemic crisis in 2011, which was complex and unprecedented, did not stop the swell of liquidity. It was a great time for asset managers, and resulted in rapid growth for all investment segments, particularly bonds. In the United States, assets under management in bond funds (all categories) grew 151%* from 2007. Assets under management in the equity segment followed the same trend, supported by historically low volatility. Investment in real assets also increased, regardless of their intrinsic quality, with a 145%* rise in assets related to European real-estate. In Europe specifically, some types of hedge funds were the big losers in this reallocation movement. Those funds were unable to stand out, due to a lack of dispersion, special situations and market swings. Abundant liquidity ended their dominance and their claims of excellence that their resilient performance during the early-2000s crisis had engendered.
The second period started in August 2015 as the end of the Fed's extraordinary policy was first announced, then anticipated, and finally realised. Exceptional arrangements require an exceptional exit. The markets responded violently to this paradigm shift, as they did when the SNB stopped its ongoing intervention in the forex market to support the euro in January 2015. Although fundamentally foreseeable, the SNB's move surprised the market and caused an immediate 15% fall in Swiss share prices. Volatility has made a comeback, and is being amplified by major doubts about whether the extraordinary monetary policies adopted recently will really have a positive impact. Although markets have not necessarily entered a sustained correction, the obvious increase in risk could alter the playing field for asset management activities again.
High liquidity prompted many asset managers, and therefore investors, to shift portfolios into higher-risk assets, particularly in the bond segment, as investors chased yield. The proportion of portfolios consisting of money-market and short-term assets has fallen by around 10 points in Europe since the cyclical peak in late 2007. Equity managers have become more focused on growth stocks as they seek to take advantage of the shift in the fundamentals in favour of those stocks. Since 2007, assets in growth-focused investments have increased twice as fast as those in investments focused on value. Bond managers have diversified by investing in areas that are sometimes less liquid. Assets under management in high-yield bonds rose more than 430%* in Europe during the period, and AuM in emerging-market debt by 330%*. Convertible bond funds have also seen massive inflows (AuM +170%*) because of their convexity. Fund ranges have become pro-cyclical, like monetary policies.
If market risk were to continue rising, it could highlight the weakness of the business model adopted by asset managers that have gradually changed their ranges to take advantage of abundant liquidity since 2008. The recent jump in the gold price, the largest since 2011, is probably a sign that investors are losing faith in investment solutions that they now regard as too risky. With tougher regulations making the situation even more difficult, we see two scenarios. The first is that monetary policies will finally give a sufficient boost to macroeconomic growth, enabling asset managers to continue attracting money with their current pro-cyclical ranges. The second is less positive, and is reminiscent of the situation in Japan. Monetary stimulus proves ineffective, and there is a real disconnect between the weak economic reality and the positions of investment funds, which are now excessively pro-cyclical. That would require asset managers to take a new approach and overhaul their fund ranges.
*Source: Morningstar, Inc., March 2016
Michaël Lok, Co-CEO Asset Management