In Equities, Rotation Is the Name of the Game

Rotation #1: Bonds to Equities 

Bond funds are on track for two consecutive months of outflows ($32bn or 0.4% of AUM YTD), according to data from EPFR. Over the same period, equity funds have recorded $153bn (0.9% of AUM) of inflows, split roughly 80%-20% between developed and emerging markets.  

Even as investors piled a record $913bn of flows into equities last year, the cumulative $850bn switch into equities since 2007 still looks low compared to $4trn into bond funds.   

Predictions of a “Great Rotation” away from bonds back towards stocks are not new.  After decades of falling yields, the question is when will conditions finally be in place for a more sustained upturn in the global rates cycle and subsequent flows out of bonds?  

Most equity fund categories have seen inflows this year, despite the MSCI AC World trading 6% lower. This is a rare occurrence historically, as such a fall in equities would typically be associated with outflows. 

There’s evidence of a US to ex-US rotation in so-called “Global” funds, which can be split into those including the US and those excluding the US. Flows into ex-US funds have outpaced US-inclusive funds for seven of the last eight months, as a percent of AUM. Investors do seem to be diversifying outside the US but were already doing so before this year’s underperformance. The shift in flows still seems small compared to the prior preference for the US-inclusive funds.  

Over the past few months, cheaper value stocks have strongly outperformed their more expensive growth stock peers. Since last November, MSCI’s global value index has traded sideways, while the growth index has fallen around 10%. Has this been driven by fund flows? The answer, according to Citi analysts, is yes – sort of. 

Flows into growth and value strategy funds, as tracked by EPFR, provide evidence that investors are indeed moving towards value, with seven consecutive weeks of inflows dating back to December of last year. This has been accompanied by six straight weeks of growth outflows to start this year. However, value inflows in 2022 are still small in comparison to those during the early-2021 value rally. Indeed, cumulative flows into value funds reached $70bn around last year’s rotation, compared to this year’s $23bn inflow. 

Citi analysts also aggregate sector-based fund flows, categorizing Tech as growth and the combination of Energy, Materials and Financials as value. Flows into the value sector funds ($15bn or 2.8% AUM YTD) have outpaced those into growth sectors ($4bn or 0.8% of AUM YTD).  

Long term, capital flows (into all bonds, US equities, growth stocks) have driven the dominant investment themes of recent years. This has pushed the valuation gaps between bonds/equities, US/RoW equities, and Growth/Value to extremes. Tentative signs are emerging that these trends may be reversing. Plenty of capital is still available to drive further rotation. For example, the latest shifts have done little to close the wide long-term gaps between equity/bond inflows or growth/value stock PEs. As Citi analysts conclude: This remains a “Small Rotation”, for now at least.  

Citi Global Insights (CGI) is Citi’s premier non-independent thought leadership curation. It is not investment research; however, it may contain thematic content previously expressed in an Independent Research report. For the full CGI disclosure, click here.