As recently as last summer and fall, respondents to BlackRock’s Global Investor Pulse Survey indicated that they held nearly half of their portfolio in cash and intended to increase that exposure over the coming year. More recent surveys tell a similar story.
But despite perceptions that investors hold a lot of cash and are still quite risk averse, my team’s analysis of the Federal Reserve’s (Fed) latest data on household financial assets suggests a somewhat different reality.
According to the Fed’s data, the share of household financial assets devoted to cash and highly-rated government bonds has been drifting lower since the end of the financial crisis and has actually fallen below the long-run average.
Meanwhile, the same Fed data also show that investors have steadily moved into ever riskier investments, especially during the recent equity bull market. Americans now hold the largest percentage of their financial assets in stocks, corporate bonds and mutual funds – a loose proxy for exposure to riskier investments – since the third quarter of 2000, near the height of the tech bubble.
The percentage of investors’ financial assets in such riskier investments is now 34.9%, just shy of the highest exposure to risky assets since the 1950s – 38.4% in the first quarter of 2000.
Behind the Shift to Riskier Investments
Part of the shift to riskier investments and away from safety is structural in nature, but much of it is cyclical.
The structural part involves the increased use of mutual funds, which have grown steadily since their introduction in the early 1980s and now account for nearly 10% of household financial assets. While mutual funds offer investors a liquid means of gaining diversified exposure to a wide variety of asset classes, around 75% of mutual fund holdings outside of money market investments are invested in stocks and corporate bonds.
At the same time, investors have also raised their risk exposure, perhaps unknowingly, due to financial market dynamics as the bull market enters its sixth year. A near trebling in equity market values and a steep decline in credit spreads since the height of the financial crisis have prompted investors to rotate back into stocks and corporate bonds. But, absent systematic rebalancing, this rotation has pushed portfolios into ever greater exposures to riskier assets, given the outperformance of stocks and corporate bonds over traditional bonds and cash during the past few years.
The Impact of the Fed
Shifting incentives have also played a very important role in investment decisions lately. Investors have reached for incremental yield as a direct result of the Fed’s decision to hold short-term interest rates near zero for the past five years and its efforts to suppress intermediate- and long-term interest rates through quantitative easing. As long as the economy continues to gain traction, investors have been willing to boost allocations to credit risk and dividend paying equities in order to obtain more yield. As a result, corporate bonds now make up 50% of all household bond market ownership – an all-time high.
At the Fed meeting last December when tapering was officially first announced, Fed officials were “concerned about the marginal cost” of additional asset purchases, fearing that more quantitative easing could lead to “excessive risk-taking in the financial sector,” according to Fed meeting minutes. My team’s analysis shows that Fed officials are right to worry about the “costs” of their highly accommodative monetary policy stance.
What Investors Should Consider
But does this mean that investors should adopt a more conservative stance? I still think that an improving global economy and growing corporate incomes will support risky assets over the balance of 2014.
However, investors would do well to consider some strategies to build some ballast into their portfolios, such as rebalancing with a tilt toward value. Rather than simply letting last year’s winners ride, investors should consider periodically rebalancing their portfolios. In particular, in today’s environment, chasing last year’s winners has been a poor strategy year-to-date. Instead, investors should consider embracing some of last year’s losers and adopting a general bias toward value-oriented areas of the market.
As for where the value is, I still believe stocks offer better value than bonds, even after a five-year bull market. Within stocks, the shift toward value from growth supports my preference for large cap and mega cap names over small cap stocks, as well as my preference for international equities and less expensive sectors of the equity market, such as energy and technology.
Sources: Linked to throughout post, Bloomberg, BlackRock research
Russ Koesterich, CFA, is the Chief Investment Strategist for BlackRock and iShares Chief Global Investment Strategist. He is a regular contributor to The Blog.
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