Money is Rotating out of Bonds, Here’s One Group of Stocks that Should Benefit.

Riding The “Great Rotation”

The “Great Rotation” is a clever name given to the expected move by investors out of fixed-income investments and into equity investments over the next few years as the bond market continues to decline.

But, like most major trends in the markets, this rotation has been slow to materialize (people have been looking for it since January/February).  But, after bond yields spiked higher in June, talk of the “Great Rotation” is back on—especially following the highly publicized $9.6 billion outflow from the PIMCO Total Return Bond Fund in June.  But, while that grabbed all the headlines, PIMCO wasn’t the only company seeing investors move out of flagship bond funds.

Outflows from fixed-income firms in June were widespread:  $14.2 billion from PIMCO, $9.8 billion from Vanguard, $6.4 billion from BlackRock and $5.3 billion from Fidelity (data according to Morningstar).

I have no idea whether this rotation out of bonds and into equities is going to be “Great.” (I don’t presume to be that smart—there are many nuances to consider in people’s asset allocations, not the least of which is a retiring baby boomer generation).  But, whether the rotation is “Great” or not, I do think we will see some rotation, and there may be an opportunity to make money off of that over the coming quarters in the asset-management space.

Keep this in mind:  Since 2009, fixed-income fund flows have been approximately $1.25 trillion, or five times the amount of the preceding five-year period (2004—’09). Conversely, equity fund inflows since ’09 were just $250 billion, which is one-third the amount of money taken in by equity funds during the ’04-’09 period.  So, if we just assume a simple reversion to the mean, you can make the case for equity asset-management shops to outperform over the coming months and quarters.

As a result of this, we should then expect potential underperformance of “bond-heavy” asset managers, and outperformance of “equity-heavy” asset managers, as over time money continues to move out of bond funds and into equity funds.

We’ve already started to see this divergence occur.  Equity-heavy managers like Affiliated Managers Group (AMG), T. Rowe Price (TROW) and Waddell & Reed (WDR)—which have the heaviest mix of equity Assets Under Management compared to debt—are at or near 52-week highs. Meanwhile bond-heavy managers like Franklin Resources (BEN), Legg Mason (LM) and, to a lesser extent, BlackRock (BLK) have underperformed.

But—I am not really a single-stock guy and it’s somewhat simplistic analysis, so I would strongly suggest doing some more homework on these names before doing anything. But, I do think these names are at least a starting point to craft a strategy (either getting long the “equity-exposed” AMs, short the “debt-exposed” AMs, or a pair trade of both).

Finally, the “equity”-focused names are all at or near 52-week highs, so in the short term they are overbought. You may want to wait for a correction (which we might get on a bounce in yields).  But, I don’t think we’ve missed the boat on this trade, seeing as the actual “rotation” hasn’t even really started yet.