Monday, 30 November 2009 00:00

Institutional Fund Allocation during 1974, 1978, and 2010

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I received this in my email1318 earlier today and thought I'd share it with my readers here and make a few comments after it.

U.S. Bonds Resemble Internet Bubble, Citi Says: Chart of Day


By David Wilson

Aug. 17 (Bloomberg) -- U.S. bonds may be just as vulnerable to a plunge as stocks were a decade ago, when the Internet bubble burst, according to Tobias Levkovich, Citigroup Inc.s chief U.S. equity strategist.

The CHART OF THE DAY depicts how an index of monthly returns on 10-year Treasury notes since 2000, as compiled by Ryan Labs, compares with a total-return version of the Standard & Poors 500 Index from 1990 through 2005. The latter gauge peaked in August 2000 and tumbled 38 percent in the next two years.

The similarities should cause anxiety, Levkovich wrote yesterday in a report with a comparable chart. He calculated that the 10-year note had a 0.87 correlation with the S&P 500 of a decade earlier, which meant its performance followed much the same pattern.

Another parallel, he wrote, is that investors are moving into bond mutual funds in the same way that they poured cash excessively into stock funds back in 2000.

About $561 billion has flowed into bond funds since the beginning of last year, according to data from the Investment Company Institute. Stock funds, by contrast, had a $42 billion outflow during the period.


A theme that also strikes home with me in investing is that people always seem to extrapolate recent events into the future. Just like in the late 1990s when money recklessly flooded into equities to chase recent good performance investors are now rushing into bonds looking for extreme levels of perceived safety and disregarding high quality equities which are now sporting the most attractive valuations in years (some of which also have dividend yields in excess of 10 year U.S. treasury notes).

On Monday I happened to come across a 1979 New York Times article that referenced Warren Buffett's 1978 Berkshire Hathaway Letters to Shareholders and highlighted his comments on institutional asset allocation. I believe it would be instructive to quote it here with the Bloomberg comments in mind:

"An irresistible footnote: in 1971, pension fund managers invested a record 122% of net funds available in equities - at full prices they couldn't buy enough of them. In 1974, after the bottom had fallen out, they committed a then record low of 21% to stocks.

A second footnote: in 1978 pension managers, a group that logically should maintain the
longest of investment perspectives, put only 9% of net available funds into equities - breaking the record low figure set in 1974 and tied in 1977."

So what is the situation today concerning the allocations of pension funds and other institutional investors? Let's examine a few relevant quotes from around the world to see if the same behavior that Warren mentioned is happening again.

The first quote is from an April 17, 2009 Bloomberg article:

"Funds overseeing money for California teachers and public workers, Dutch government retirees and South Korean private- sector employees reduced their target weightings for equities this year, data compiled by Bloomberg show. The rest of the 10 largest kept them the same. U.K. pensions have cut stock allocations to the lowest since 1974, according to Citigroup Inc. Managers handling Oxford and Cambridge University professors assets have been selling shares as the MSCI World Index posted a five-month, 51 percent rally."

Here are several more recent quotes from a June 11, 2010 article in Investments & Pension Asia

"Research for the survey was conducted in May 2010. Questions were sent to a wide cross-section of pension funds, almost half (46%) of which are corporate followed by public pension funds (30%) and endowments (8%). They have a total of $110bn under management. The pension funds have, on average, a 44% target allocation to equity, 37% to bonds, 16% to alternatives and 3% to cash.

Given the difficult environment in the lower-quality sovereign bond segment, investors six-month tactical views reflect a more moderate appetite for bonds (though it is far from negative). Indeed, most of the respondents do not anticipate any change in their bond target asset allocation in the next six-months while 13% anticipate an increase and 11% a decrease"

How are the Europeans looking at this issue? Here is a quote from a Finfacts Ireland April 2010 article:

"Mercer, the international pensions consultants, said on Thursday that the move away from shares is particularly evident in the more mature defined benefit markets such as the UK where the allocation has fallen from 54% in 2009 to 50% in 2010. In Ireland it has reduced from 60% to 59% and in the Netherlands from 28% to 23%. This trend is likely to continue, with 29% of UK schemes and 35% of European schemes (ex-UK) planning further reductions in domestic equity. A further 20% of UK schemes and 33% of European schemes (ex-UK) are planning a reduction in non-domestic equity.

Bonds continue to form the largest part of most European pension funds investment portfolios, and this looks set to continue. For example, following the significant rally in equity markets, a net 27% of European (ex UK) schemes plan to increase their exposure to government bonds."

So it would seem that institutional investors have no learned the lesson from their experiences in 1974. They are once again not taking a long term viewpoint and are extrapolating recent trends into the future. They ran out of stocks when they should have been buying them in the downdraft of 2008/2009 and are now increasing bond allocations when they should be increasing their large exposure to high quality equities. After all would you prefer owning a 10 year US Treasury Note yielding 2.69% (as of 08/17/1010) or high quality equities which in some cases can be purchased with yields exceeding 10 year bonds? For example JNJ just sold $550 million of 2.95% 10 year notes, has a P/E of just over 12 and sports a dividend yield of 3.7%. The choice, for me, would be easy.

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