Investors planning a tactical shift away from equities because of overstretched valuations risk substantial underperformance if they mistime their exit or re-entry, according to consultancy firm Cambridge Associates. 

In a new analysis of valuations and returns, Cambridge said that while valuations should not be ignored, investors who attempt to time the market risked missing out on the highest returns, which tend to be concentrated over very short periods.

The consultancy said the high price-to-earnings ratios in some equity markets suggested low future returns, tempting investors to move substantial amounts out of the asset class.

While UK equities were still within their ‘fair value’ range, Cambridge said, an analysis of 117 years of data showed that, from current valuation levels, subsequent 15-year real returns could be expected to be around 5%.

However, the consultancy warned that, since 1900, being out of the market for just the two best quarters could cut the cumulative real returns on UK equities by more than 50%.

Over the longer term, missing the 10 best quarters since 1900 resulted in more than 90% of the gain on UK equities being wiped out. Conversely, investors who miss the two worst quarters of returns would almost double their cumulative real gains on UK stocks, Cambridge reported.

US equities showed an even more marked trend, the study found, with the best two quarters for returns comprising more than two thirds of the cumulative real returns since 1900.

Alex Koriath, head of the European pensions practice at Cambridge Associates, said: “While no investor should be ignoring valuations, becoming too focused on timing an exit has substantial risks. The best periods for returns tend to be very concentrated, meaning that exiting at the wrong time could drag down cumulative returns significantly.

“In the light of these reduced return expectations, some investors are seeking to lower fees by switching to an all-passive strategy through index tracking. But this actually maximises their exposure to any fall in the equity markets.

“Now is the time for active management and low beta. Better returns might be delivered by a balanced long-term portfolio of equities and bonds, along with assets like absolute return hedge funds and less-correlated private market strategies, including both private equity and credit.”

However, Koriath emphasised that his company was not advising a wholesale move into active management. “We are advising against carrying out a big tactical trade,” he said. “Instead, investors should include different styles and asset classes.”

Making a big tactical shift out of equities would not be affordable for many pension funds with deficits, he added.

He told IPE: “Moving out of risk assets means they can expect lower future returns, which means not achieving the target of 100% funding over the planned recovery period.”

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