Follow the money?

Volatile equity markets are not stopping fund managers taking risks, but they are side-stepping bonds and lifting cash deposits.

PORTFOLIO POINT: Domestic fund managers are lifting their cash allocations, but they’re not ditching risk assets.

What are funds management asset allocations telling us about the market?

Last week, I looked at one subset of the market, professional traders, and examined how they were positioned. I’ll be honest in telling you that some of the results surprised me, given the global backdrop. But it got me thinking about what domestic real money investors are doing, and whether there might be some surprises. Data is harder to come by and a little less timely for this group – the latest figures are for the March quarter – but thankfully, the kind folk at the Australian Bureau of Statistics have provided me with data on funds under management in Australia.

The first point to note, and referring to Chart 1 below, is that funds under management (FUM), including self-managed funds, have increased by $82 billion over the last two quarters, to $1.47 trillion, with about $67 billion of that in the last quarter alone.

Chart 1: Australian funds under management

This is a new peak and the largest six-month increase in total FUM since the December quarter of 2009. Taking into account the $15 billion (approximately) per quarter that flows into super coffers from the earnings of employees brings the performance gain down to about $50 billion. But it is still a new Australian record, and up some $20 billion from the previous peak in the March quarter of 2011.

Unfortunately, looking at how FUM has grown since the March 2011 peak reveals that performance is not as good as the headline number might suggest. Total FUM is up by $25 billion, sure, but accounting for inflows of $60 billion, you’re looking at a loss in managed funds of $40 billion or so. Sure enough, it was the considerable turmoil throughout 2011 that saw about $56 billion wiped off from the March quarter 2011 peak to the September quarter 2011 – which, if you take into account those regular inflows, is more like $100 billion. This was not a pretty year. But it wasn’t as bad as the GFC, when over $260 billion in FUM was lost or almost 20% of total funds under management.

But anyway, the first point is that since the turmoil of late last year, funds under management have been slowly rebuilding and this is due to more than just super inflows (which pretty accounted for the gains of 2010-11). So what are money managers doing with these funds?

It’s true to say that through this period there has been a surge in monies allocated to deposits. Chart 2 shows that deposits held by fund managers are at a record, increasing by $13 billion over the last six months to around $203 billion.

Chart 2: Deposits held by fund managers

That may only be a modest increase in the proportion of total funds allocated to deposits – 13.6% in Q1, from 13.7% – but Chart 3 shows how the proportion of funds allocated to deposits has actually increased sharply, almost doubling since pre-GFC levels (and they keep on growing). So while total FUM has increased by about 17% since pre-GFC levels, deposits are up by some 115%.

Chart 3: Asset allocation to deposits – proportion of total FUM

At face value, it would be reasonable to conclude that fund managers – and their clients who provide the funds – are much more conservative. Risk aversion reigns supreme. Certainly, you can see from the above chart that this signals a marked shift in allocation. This would seem to be a pretty straightforward conclusion, except when you look at the same charts for stocks. Chart 4 shows how shares under management have fared over recent years.

Chart 4: Domestic shares held by fund managers

You can see from the above chart that domestic shares under management are now above their pre-GFC peak, with $424 billion under management. At the same time, though, the All Ords hasn’t quite recovered to its pre-GFC peak and in fact remains some 40% below. That’s telling me there is still a sizeable amount of cash being thrown into stocks every quarter. You can get a sense of it with some back-of-the-envelope calculations: prices are down 40% since the peak, which would imply FUM in this component of $250 billion currently, not the $424 billion that the latest figures say we’ve got. So that’s $175 billion of inflows that must have come in to compensate for the price fall (not accounting for any dividends reinvested). This compares to total inflows into super from salaries and the like of $270 billion (using that approximate $15 billion per quarter inflow figure). That’s almost two-thirds of fund inflows going into equities. From that, I’m not really getting the sense that real money managers or their clients are particularly risk averse. There has been ample time for employees to instruct their funds to change their mandates; even taking into account some degree of investor lethargy, this would occur if they were really concerned. But employees haven’t acted.

So, allocations to cash are higher, suggesting a newfound conservatism, but then again allocations to shares have been strong, suggesting the opposite. So what gives?

Chart 5: Overseas assets held by domestic fund managers

We can probably get a better sense of what is happening looking at other asset classes. Chart 5 above shows FUM allocated to overseas assets. Note the sharp drop in FUM following the GFC – certainly, valuation changes would loom large here – but overall, funds and their clients clearly went underweight. Indeed, FUM allocated to overseas assets fell to 16.5% from the prior average of about 19%. However, since then – and in particular, the most recent quarter – we have seen a sharp rebound in funds allocated to overseas assets. We’re not quite back at pre-GFC levels (19% of FUM) but at 17.4%, we’re not too far off and the increase in overseas FUM in the March quarter was the biggest in almost six years.

It’s a similar story when we look at investment in land, buildings and other equipment. Chart 6 below shows a solid rebound in FUM here.

Chart 6: Land and buildings held by domestic fund managers

About the only classes in which we’re seeing a decline in FUM is bonds and short-term debt securities (check out Chart 7).

Chart 7: Bond and short-term debt securities held by domestic fund managers

Bond allocations have been hit hardest, especially when you consider that bond prices have risen so sharply. Consider that Aussie 3- and 10-year futures are up about 150-60 ticks in price over the last year and nearly double that compared to pre-GFC levels. Yet funds allocated to bonds are down $10 billion or so compared to pre-GFC levels. That may not sound like a lot, but remember the $15 billion in inflows we see every quarter and the very sharp price appreciation for bonds. The magnitudes may not be so aggressive for short-term debt securities, but the picture is the same. This is clearly a very aggressive allocation out of bonds and short-term debt; again, inconsistent with the idea that investors are bearish on economic prospects. At this point, recall last week’s piece showing that professional traders thought the bond market was a bubble waiting to pop. The rally has continued for sure, but the risks are too high to play this game when you consider the dramatic intervention of central banks. It seems Australian real money accounts hold a similar view – too risky on price and not enough yield.

All up, I’m not getting the sense that real money accounts are especially worried or nervous. Cash allocations are rising, but this appears to be at the expense of bonds and short-term debt securities rather than equities, property or overseas allocations – even through the turmoil of late last year. June quarter data will likely show a drop-off in FUM allocated to equities, but like last year, this will probably be due to valuation effects rather than a marked change in asset allocation. During times of distress recently, it doesn’t appear that real money accounts are avid sellers of risk – it’s more the case that they aren’t bidders in the market, preferring instead to wait for volatility to subside. And I think that’s what the data has been telling us over recent years: that real money accounts in Australia aren’t fearful or cautious, but just patiently waiting for things to stabilise.