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Equity outflows nearly matched by bond inflows in big asset allocation shift

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The higher yields available on bonds is tempting investors back in while they’ve dialled down equity holdings.

This asset allocation switch has seen equity outflows of £5.1bn, nearly matched by £4.9bn which has flowed into bonds since July 2022.

According to data from global fund network Calastone, outflows from equity funds accelerated in February as investors pulled £581m from these holdings while bond market inflows also “moderated” with £834m allocated.

This is the third best month in the past two years but Calastone said this month’s figure was down on January’s near-record net purchases.

It explained that Government-backed bonds with extremely short maturities are the least volatile asset class and they are currently paying the highest level of interest in more than a decade. In months when investors flee from equities, money market funds typically tend to do better. These funds saw inflows of £315m in February.

UK equities “were by far the least popular sector” in February, despite the FTSE 100 reaching record highs in the month, and falling far less than global peers “as market confidence waned”.

Calastone noted that investors dumped £962m from their UK-focused equity fund holdings, making it the third worst month for the sector on record.

Further, February also marked the 21st consecutive month of outflows from UK-focused equity funds.

Meanwhile, European equities suffered their 17th month in a row of outflows with £250m leaving investor portfolios in the month.

In the US, sharp falls in the stock market also saw investor redemptions reach £368m from North American equity funds, more than double January’s level.

The £50m outflow from Asia-Pacific “almost exactly” reversed January’s modest inflow.

But Calastone said “it was not all bad for equity funds” as those with a global mandate garnered £1.08bn in new capital, the majority of which was made early on in the month when markets were still rising.

However, and rather unusually, this wasn’t propped up by ESG funds which attracted £466m while the majority (£613m) came from ‘traditional’ global funds.

‘UK investors can’t be persuaded to stick with UK equities’

Edward Glyn, head of global markets at Calastone, said: “Stock markets have sagged on the realisation that the interest-rate medicine prescribed to control inflation will be needed in higher doses and for longer. The UK economy may need more rate hikes too, but its stock market nevertheless has some natural resistance to the valuation compression that higher rates mean for asset prices, owing to its relatively low growth/high cash flow profile.

“Yet UK investors cannot be persuaded to stick with UK equities, despite their extremely strong relative performance over the last year. It is clear that a structural diversification is under way to reduce the relatively heavy weighting in UK investor portfolios to UK-focused funds. The general air of pessimism over the UK’s economic decline, weak government finances, political chaos and rising corporate taxes seems to have accelerated this trend with consistent outflows from UK funds and inflows to global ones.”

Glyn added that the inflows to fixed income funds are “interesting”.

He said: “Like equities, bonds have also endured a bear market over the last year, yet these funds have enjoyed inflows even as equity funds have suffered outflows. There are two factors at play. First, investors are structurally overweight equities. Years of strong market performance not only attracted new cash to equities but also saw existing holdings swell in value – equity funds assumed an ever-larger weighting in investor portfolios as a result.

“Equity and bond prices have already suffered the value compression that comes with higher interest rates, leaving bonds offering the most attractive yields since before the Global Financial Crisis, as well as the prospect of capital gains if a recession bites and market interest rates fall. Meanwhile, equities are at risk from a second downturn if that same recession bites into profits.”

He added that fear of losses on equities and enticing interest income are “all working in favour of fixed income at present.”

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