The Great Rotation That Wasn’t
In the end, ETFs show it was all about duration.
January 20, 2014
Remember the “great rotation” everyone was talking about last year? It was that watershed moment when investors would finally dump their bonds and flow back into equities en masse. People stopped talking about it at about the same time the term “tapering” made it into the popular lexicon. Now everyone is waiting for tapering to kick investors out of bonds and back to equities as the U.S. Federal Reserve eases up on its historic bond-buying spree.
Whichever buzzword you choose—rotation or taper—the question really is: Has all this talk translated to action? Are investors finally running away from bonds and back into stocks?
Yes and no. Investors have been shuffling their bond portfolios. But if you look at what’s happening in the ETF space, it’s not really the kind of great rotation everyone thought it would be.
According to BlackRock’s ETP report, investors pulled their money from long-duration bond funds—but they put it right back into fixed income in the form of shorter-maturity products. So while fixed income ETF flows were down last year, short-maturity products gathered considerable steam to the tune of $34.7 billion.
Call it the great duration rotation.
There’s another area that proponents of the great rotation also overlooked—emerging market debt. In the pension space, providers have been talking to plan sponsors about emerging market fixed income for the past few years, working to educate and gain traction in pension boardrooms across the country. But while plan sponsors have boarded the emerging market equities bus, they still have a way to go before they fully embrace the bond side of the equation.
That might change in 2014.
A quick look at the ETF space shows that momentum is set to gather in the mainstream as investors take a serious look at emerging market bonds. Sure, emerging market bond funds did poorly last year. But the demand for emerging markets bonds is strong in 2014 so far—and the market is looking pretty robust as investors respond to a flurry of new issuance from oft-overlooked countries in Eastern Europe (Poland, Latvia and Romania) where funding costs are low and bonds are now plentiful. Since the start of 2014, emerging market sovereigns have sold almost $19 billion of bonds—three times more than what was sold at the same time last year.
All that activity should have a much-needed knock-on effect in the ETF space say some.
Meantime, for investors waiting for that great rotation to happen—well, it might be a long wait. As the fixed income universe expands and as investors focus more on duration, the equity versus bonds discussion is getting a lot more complicated. In the ETF space, that could just mean emerging market bonds will finally get their chance to shine.