Bill Gross, the bond market guru, reckons the cult of equity is dead; Nassim Nicholas Taleb, the hedge fund guru, advises smart kids to shun careers in investment management and the jobs in stock trading continue to fall like autumn leaves on Wall Street and in the City of London.
If you needed more evidence that it's all over for brokers, some statistics emerged last week from the U.K. Pensions Regulator that confirmed that the flight from risk is real. The share of equity across Britain's 6,000 defined benefit pension schemes has for the first time fallen below that of bonds. Some might think it a lagging indicator, especially among those who see the present stock market malaise as a buying opportunity. But this watershed moment may be time to consider why funds continue to shun apparently cheap equity shares. If pension fund managers are avoiding equities for any reason other than investment fashion, we shouldn't expect any pole vault to high equity returns.
The reason funds are deserting stocks could be simple demographics and the gradual destruction of a bulwark of the West's great society of privilege and entitlement: the guaranteed pension. The pension scheme that guaranteed you an income based on a final salary is becoming a rarity, almost unavailable to new staff. However, there are plenty such funds still going and the liabilities are increasing as we live longer, forcing fund managers to carefully match the scary burden of paying annuities with income-producing assets. In a low-inflation, low-interest rate environment, fixed-income investments are a no-brainer. You buy bonds because risk is a luxury – there are no new members to boost the fund with new income and chasing higher equity returns could lead you to perdition.
In such a world of very slow but guaranteed extinction for defined benefit pension funds, managers have no choice but to shun risk. To do otherwise would be to expose their funds to losses, potential bankruptcies and fiduciary claims from penniless pensioners. The ever lengthening tail of maturing final salary schemes is made worse by the tax burden imposed by the public sector. Most governments have yet to grab the demographic nettle and begin to trim the ballooning payouts to retired teachers, firefighters, nurses and civil servants. Instead, the private sector pays for the public pension as it scrimps and saves for its own less comfortable retirement.
According to Bill Gross, equities have been a sort of scam since the beginning of the 20th century. He wonders how they could have delivered returns averaging more than 6 per cent per annum when the economy was expanding at half that rate. Half-jokingly, Gross describes the equity market as a ponzi scheme – the classic fraud in which later investors provide the payout for early investors and which recently achieved notoriety with the exposure of Bernard Madoff's fund.
We should not expect that the animal instincts of professional private investors will fill the gap in demand created by these other money managers' exit. The fraud and incompetence exposed over the last five years has certainly had a chilling effect on investors, and there is no doubt it has reduced risk appetite. There is another possibility: that increased regulatory attention to markets has also reduced risk appetite. We know that insider trading was rife in the early years of stock markets. Efforts to prosecute offenders only became intense during the boom years of the late 1990s when computer data analysis made it possible to trace transactions quickly.
Only a cynic would say that equity markets can only produce good long-term returns for insiders. But the financial crash of 2008 has given us all a lot to be cynical about.