Stock pickers are banking on 25% returns in a market strategy that Wall Street experts call 'highly unrealistic'
- According to Bernstein, stock pickers are flocking to "alternative investments" - defined as infrastructure, commodities, hedge funds, real estate, and private equity.
- The problem, Bernstein says, is that pension funds implicitly require their alternative investments to bring in 25% return per year net of fees.
- "The returns being demanded from alternatives are unrealistically high."
The stock market is shrinking. Returns are getting harder to come by. And costs for passive stock strategies are getting lower.
What's a stock picker to do?
According to analysts at Bernstein, they're flocking to "alternative investments," which the firm defines as infrastructure, commodities, hedge funds, real estate, and private equity, among others.
Alternatives are playing a much bigger role in pension fund and endowment portfolios. The problem is that, by Bernstein's calculations, pension funds implicitly require their alternative investments to bring in 25% return per year, net of fees.
"The returns being demanded from alternatives are unrealistically high," Bernstein analysts led by Inigo Fraser-Jenkins wrote in a note on Monday. The firm notes that while a 25% per year return "may appear an outlandish claim" ... "this is our view of the implicit expected return, not the explicit forecast made by funds which are making such allocations."
Bernstein explains how it calculated that figure in the note under the chart below:
Bernstein outlines its reasoning behind the trend:
"There are legitimate reasons for the increased allocation to alternatives: a low return future, a shrinking public equity market, the falling cost of passive and factor strategies and a likelihood that diversification becomes harder to come by. However, there are reasons for this allocation which we think are mistaken as well: the expected returns from alternatives seem too high and more fundamentally the alternative/non-alternative distinction is fake and gets in the way of efficient fee allocation."
The allocation to alternatives has surged in the past 12 years, while the trend for the "passivisation" of investment in public stock markets and more active allocation in private markets isn't going anywhere.
"Given the huge momentum behind this rotation, we won't reach peak alternatives for many years," Fraser-Jenkins said.
The stock market is shrinking, and buybacks are to blame
One reason behind the exodus of active managers from public equity markets is the stock market getting smaller. As a result, big returns are becoming harder and harder to find.
"Global developed markets are seeing buybacks being greater than issuance and so the available stock of equities is shrinking," the report said. "The shrinkage in the stock market has merely been disguised by prices going up."
Here's a chart showing just how much smaller the US stock market has gotten (note that in emerging markets, there's ample supply of equities:
