Pension funds should follow Warren Buffett's reputed lead and invest in zero-coupon bonds, some top fixed-income managers say.
The managers argue zero-coupon issues offer a better risk-reward profile than equities at current levels, and better match the liabilities.
Other bond managers agree bonds offer better value than stocks at current levels, and some have seen pension funds rebalancing portfolios to give more weight to bonds.
Said William Gross, managing director of Pacific Investment Management Co., Newport Beach, Calif.: "Aside from the sheer amount of risk, a long zero provides a much better hedge against liabilities than does intermediate bonds.
"For pension funds, they're not a bad investment going forward and never have been. The returns, I think, outweigh the risks."
PIMCO manages $106 billion in assets, 95% of which is in bonds.
Wayne Lyski, chief investment officer of Alliance Fixed Income Investors, New York, also thinks pension investors should consider zeroes.
"If you're looking at the high beta play in the U.S. bond (Treasury) market, that is clearly what you want to do," he said.
"You won't plow as much absolute money into it, and it's relatively attractive because for the foreseeable future, the Federal Reserve is not going to embark on an easing policy. To the extent that there's an upside in the market, it will likely emanate from the 10-year maturity level on out. If a reallocation process is going on, that's likely where it should occur."
Alliance Fixed Income Investors manages $80 billion in global assets.
Some movement to bonds
Mr. Lyski, meanwhile, said he has seen a "pervasive, but not huge" movement by pension funds into bonds.
"Many entities have mandates, particularly state pension funds, that say they can't have more than x-amount of assets in equities. Many are bumping up against caps, in some cases legislated caps, so there's an automatic rebalancing happening there.
"There's others who are simply looking at returns, particularly in the U.S. Treasury market, and saying that, for a purely risk-return basis, we should move some of our assets," Mr. Lyski said.
Mr. Gross, by contrast, said only a few clients - "not more than I can count on my two hands" - have taken money out of the stock market and put it into the bond market.
"Over the last several months, I think we've seen about $1 billion that you could properly identify that has been rebalanced to fixed-income by our clients," he said.
But Robert Kapito, vice chairman of BlackRock Financial Management Inc., New York, said: "We are seeing pension funds reallocating 5% or more out of their stock portfolios into bonds."
Mr. Kapito believes "a core account is a good place for fund assets. We feel funds should take advantage of a mixed allocation to the Treasury market, the mortgage market and the corporate market."
Great opportunity
"In my 15 years in this business, I don't think I've ever seen a period of greater opportunity in the bond market.
He acknowledged that concern over the run-up in the stock market "has become the backdrop for people looking to reallocate some portion of their equity into the bond market."
BlackRock Financial manages more than $50 billion in fixed-income assets.
Added Kent Newmark, managing partner at Loomis, Sayles & Co.'s San Francisco office: "I believe the stock market is so out of sight relative to bonds that whatever your weighting is right now, I would have more in bonds, less instocks and probably a little more in cash today than I did yesterday."
Loomis, Sayles' San Francisco office manages approximately $5 billion of the company's $29 billion in institutional fixed-income assets.
Tough to abandon stocks
Despite this enthusiasm, bond managers acknowledge many pension fund executives are reluctant to abandon the perceived field of dreams that is the stock market of the late 1990s.
Steve Algert, director of fixed-income research for Rogers Casey's San Francisco office, said some pension fund executives are reluctant to depart the equity market, choosing instead to remain above their target allocation to stocks.
"There are even a few instances where they are increasing their targeted equity allocation," he said.
Most interest in rebalancing out of stocks and into bonds has come "more from the investment manager side than the plan sponsor side," said Thomas A. Shively, chief investment officer for fixed income at State Street Research & Management, Boston.
Managers see better value in bonds in "a risk-return sense, where sponsors tend to be a little more focused on expanding the return."
"There's not a lot of strategic activity at the sponsor level," Mr. Shively said.
He's convinced, however, it "does make sense, on a risk vs. reward basis, to be moving money into the bond market. I think you will see a narrowing of the return differential between the two asset classes and, ultimately, the risk in the bond market is less than (in) the stock market."
Craig McCauley, managing director of global fixed income at Bankers Trust Co., New York, believes investors also are looking for alternative fixed-income investments.
Pension funds might do well to combine traditional holdings - such as high-yield and Treasury bonds and mortgages - with non-traditional ones.
"Things such as global fixed income and emerging markets provide pension funds with a broader perspective and spread the risk across various asset classes," Mr. McCauley said.
Bankers Trust manages approximately $85 billion in institutional fixed-income assets.
Mr. Shively said he has seen some interest - though "not dramatic" - in "broadening guidelines of fixed income to enhance return," such as investing in foreign securities, international emerging markets and high-yield bonds.
"Pension funds find themselves in the place of having larger surpluses, so their ability to take incremental risks is greater. They are also anticipating less return from all capital markets," Mr. Shively said.
"But you have to wonder whether, when the good times end in the stock market, they wouldn't be better served to have had more Treasuries."
State Street Research manages about $27 billion, of which $23 billion is in institutional fixed-income assets.
What's spurring the market?
Fixed-income managers see several factors spurring the bond market:
Increasing overseas interest in the domestic bond market;
A declining domestic deficit, which could mean fewer Treasury bond issues;
The need by large bondholders such as insurance companies to reinvest their cash; and
The Federal Reserve's "willingness to tolerate growth without inflation," according to Mr. Kapito.
Over the next six to 12 months, Alliance's Mr. Lyski foresees a scenario "where the yield curve gets flatter on the long end, down to say 5.75% or 6%. To go lower than that, you would have to see the Federal Reserve ease up its policy," which seems unlikely.
Of course, a lower bond yield in 1998 would "probably mean a still-higher stock market," Mr. Lyski acknowledged.
Bankers Trust's Mr. McCauley predicted interest rates would remain relatively stable over the next year, with U.S. 10-year bonds "staying around the 6% mark."
He added it's likely the "Fed will tighten around the end of the year and into early 1998."
