Great Rotation Seen Muted by Pension-Fund Demand: Credit Markets
A shift by household investors from bonds into equities that Bank of America Corp. dubbed the great rotation is being muted as pension funds and insurers boost fixed-income assets to match future obligations.
U.S. companies with the largest defined-benefit pensions increased allocations into fixed-income to 41.3 percent from 36 percent since 2010, putting a greater share into the market than into equities, according to JPMorgan Chase & Co. (JPM) analysts and data from actuarial and consulting firm Milliman. Life insurers are replacing maturing structured securities with corporate bonds, and sovereign-wealth funds with $4.3 trillion of assets are investing 90 percent of it into debt, the analysts said.
“If there were this rotation from individuals from bonds into stocks and it created higher yields and stronger stock performance, it would quickly find a match on the other side of the trade from the institutional pension community,” money manager Jeffrey Gundlach, whose $33.9 billion DoubleLine Total Return Bond Fund had its biggest net withdrawal in September, said in a telephone interview. “I don’t think it’s some sort of runaway condition.”
The demand from institutional buyers is mitigating $166 billion of withdrawals from bond funds earlier this year amid mounting concern the Federal Reserve was poised to start scaling back stimulus measures that have pumped more than $3 trillion into the financial system. Bank of America strategists in January called a retreat from corporate bonds by mutual-fund investors the “biggest risk” to investment-grade debt.
Yields on dollar-denominated, investment-grade debt, which fell to a record low of 2.65 percent on May 2, have since risen to 3.33 percent, according to the Bank of America Merrill U.S. Corporate Index. The higher rates have attracted institutional investors to add to their positions, JPMorgan analysts led by Joyce Chang, the New York-based global head of fixed-income research, wrote in a report last week.
Pension funds and insurance companies are matching their liabilities to prepare for the retirements of about 78 million U.S. baby boomers, or those born from 1946 to 1964, boosting demand for fixed-income assets.
“I find it difficult to believe that an aging investor population is going to be ratcheting up their holdings in riskier assets,” said Gundlach, chief executive officer of Los Angeles-based DoubleLine Capital LP.
Elsewhere in credit markets, the cost of protecting corporate bonds from default in the U.S. declined, with the Markit CDX North American Investment Grade Index, which investors use to hedge against losses or to speculate on creditworthiness, decreasing 0.1 basis point to a mid-price of 73.2 basis points as of 10:34 a.m. in New York, according to prices compiled by Bloomberg.
The measure typically falls as investor confidence improves and rises as it deteriorates. Credit-default swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a contract protecting $10 million of debt.
A gauge of the health of U.S. financial conditions fell from a record high. The Bloomberg U.S. Financial Conditions Index (BFCIUS), which combines everything from money-market rates to yields on government and corporate bonds to volatility in equities, decreased 0.03 to 1.78. The gauge ended yesterday at 1.81, the highest level in data dating back to January 1994.
Bonds of Verizon Communications Inc. (VZ) are the most actively traded dollar-denominated corporate securities by dealers today, accounting for 4.8 percent of the volume of dealer trades of $1 million or more, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. The New York-based telephone carrier raised $49 billion on Sept. 11 in the largest corporate bond issue ever.
Bank of America credit strategists led by Hans Mikkelsen in New York warned last year that by the end of 2013, mutual fund investors may be retreating from corporate bonds. A disorderly rotation from bonds causing borrowing costs to soar “is the biggest risk to investment grade this year and the one we are getting increasingly concerned about,” the analysts said in a Jan. 28 report.
After the Fed signaled in May that it may curb $85 billion in monthly bond buying that has bolstered debt prices, investors tempered their demand for fixed-income assets. The pace of cash deposited into debt funds has declined to $171 billion this year, compared with a record $855 billion in 2012, according to the JPMorgan analysts. After investors pulled $17 billion starting in June from funds that invest in investment-grade corporate debt, they returned $12 billion in the two months ended in October, they said.
Corporate borrowers are still finding a receptive debt market with global sales about 4 percent below last year’s record pace of $3.9 trillion, Bloomberg data show.
“There’s a very large portion of the bond market who can’t rotate” out of bonds and into stocks because of their investment guidelines, said Guy LeBas, chief fixed-income strategist at Janney Montgomery Scott LLC in Philadelphia. Some individual investors “have moved out of fixed income and into equities. It has an impact but not enough to move the market by percentage points.”
Institutional investors, rather than individuals, own the vast majority of corporate bonds, controlling about 90 percent of investment-grade securities and 75 percent of high-yield bonds, according to the JPMorgan analysts, citing figures from data providers EPFR Global and Lipper.
The decline in issuance of structured debt such as mortgage-backed securities has left fewer choices for investment managers. Net sales of all credit-related securities are estimated to reach $521 billion in 2014, down from more than $1 trillion in 2007. Sovereign wealth funds are increasing assets by about $500 billion annually, boosting demand for fixed-income investments.
“There’s a continual need from the traditional fixed-income players,” Matthew Duch, who helps oversee $12 billion as a money manager at Bethesda, Maryland-based Calvert Investments Inc., said in a telephone interview. “The demand for fixed-income will always be there.”
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