August 9, 2013 / 2:51 PM / 4 years ago

INVESTMENT FOCUS-"Great Rotation" party risks becoming crowded

LONDON, Aug 9 (Reuters) - The world's biggest state-backed funds are joining the "Great Rotation" portfolio switch out of bonds into equities, a move that risks crowding the trade and lessening the allure.

The shift into higher-return equities out of low-yielding bonds is one of the top investment themes of 2013, driven mainly by U.S. private pension funds and retail investors.

But recent plans by Japan's $80 billion pension fund to increase equity weightings at the expense of bonds and Norway's move to boost stocks and cut some bonds highlight a greater involvement from the world's biggest and influential investors.

The sheer size of these funds means even a small switch in their asset allocation could easily elevate prices, raise valuations and close the value gap equities offer over bonds.

"It's now driven by almost all types of investors. If you take a rational decision and try not to time the market... equities are still the most attractive asset class," said Dirk Wiedmann, head of investments at Rothschild Wealth Management.

"We're all being forced to take equity risks. We do it because it's the most attractive of not so attractive options. Do I feel very comfortable? The answer is no... The fundamental case for equities is weakening."

According to most recent estimates by Thomson Reuters Lipper, equity funds and Exchange-Traded Funds had net inflows of $60 billion in the past four months, which represents around 0.8 percent of total assets.

Bond funds and ETFs had net outflows of $22 billion, which represents around 0.5 percent of total assets. In June alone net outflows from this group were $78 billion, or 1.7 percent of total assets.

The pension fund for Japan's civil servants is considering changing its strategy to allocate more of its $80 billion to stocks and less into domestic government bonds.

Its current asset mix may almost guarantee a capital loss - it invests nearly 80 percent in Japanese Government Bonds and just 5 percent in domestic stocks.

The move follows the $1.2 trillion Government Pension Investment Fund, which raised its Japanese stock allocation in June to 12 percent of its portfolio from 11 percent and lowered JGB holdings to 60 percent from 67.

Norway's $760 billion sovereign wealth fund has increased equity holdings to 63.4 percent of its portfolio from 62.4 percent three months ago and cut its government bonds weighting, especially in Britain.

"It is less a reflection of our enthusiasm for equity markets and more a reflection of our lack of enthusiasm for bond markets," Yngve Slyngstad, chief executive of the Norwegian SWF, told reporters on Friday.

VALUATIONS

But just as long-term investors join the equity rally, reasons for aggressively buying equities may be becoming less compelling.

Bank of America Merrill Lynch says the S&P 500 index has been in a bull market for more than 50 months since March 9, 2009, nearing its historical average since 1932 of 57 months.

Valuations are starting to be unappealing. The Shiller price earnings ratio, which measures equity prices relative to average earnings over the past 10 years, stands at 24, above the long-term average of 16.

"Valuation on balance is okay but not a screaming buy," Wiedmann said.

Rothschild is hedging almost half of its equity positions using derivatives.

"On balance liquidity is the only convincing reason to buy." (Additional reporting by Gwladys Fouche and Joachim Dagenborg in Oslo and Joel Dimmock in London; Editing by Ruth Pitchford)

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