Aging is the largest factor affecting investor behavior in mature economies. As investors enter retirement, they typically stop accumulating assets and begin to rely on investment income; they shift assets from equities to bank deposits and fixed-income instruments. This pattern has led to predictions of an equity sell-off as the enormous baby boom generation in the United States and Europe enters retirement (the oldest members of this cohort reached 65 in 2011). We find this fear is somewhat exaggerated, but the effects of aging are real: if investors retiring in the next ten years maintain the equity allocations of today’s retirees, equities will fall from 42 percent of US household portfolios to 40 percent in 2020—and to 38 percent by 2030. In Europe, where aging is even more pronounced, we see an even larger shift in household portfolios.
Also influencing equity allocations in mature economies are the shift to defined contribution retirement plans in Europe and rising allocations to alternative investments. In Europe, we see that defined-contribution plan account owners allocate significantly less to equities than managers of defined-benefit plans. And as private pension funds close to new contributors, managers are shifting to fixed-income instruments to meet remaining liabilities. Meanwhile, institutional investors and wealthy households seeking higher returns are shifting out of public equities and into “alternative” investments such as private equity funds, hedge funds, real estate, and even infrastructure projects. Although we estimate that some 30 percent of assets in private equity and hedge funds are public equities, the shift is still causing a net reduction in allocations to equities.
Another factor weighing on demand for equities is weak market performance. The past decade has brought increased volatility and some of the worst ten-year returns on listed equities in more than a century. In opinion polls, Americans say they have less confidence in the stock market than in any other financial institution and believe that the market is no longer “fair and open.” However, to put these sentiments in perspective, it is also worth noting that individual investors can have short memories and may be willing to return to equities in the event of an extended rally.
The final factor is the effect of financial industry reforms on the uses of equities by banking and insurance companies. US and European banks today hold $15.9 trillion of bonds and equities on their balance sheets. But new capital requirements under Basel III will prompt banks to shed risky assets, including equities and corporate bonds. Similarly, European insurers have already reduced equity allocations in anticipation of new rules, known as Solvency II, and could lower them further over the next five years. At a time when European banks need to raise more capital, Solvency II constrains the insurance sector as a potential purchaser of that equity.