While asset owners are rotating out of traditional core fixed income, they're not necessarily interested in moving all the way into equity-level risk, meaning the “great rotation” back into equities might not be imminent.
Moves out of traditional fixed income have primarily been within core strategies that are benchmarked to the Barclays Capital U.S. Aggregate index, which has seen declining yields due to increased exposure to U.S. Treasuries in a low-interest-rate environment.
“Investors are not interested in decreasing their allocations to fixed income. I think some people expected investors to start shifting away from fixed income and into other assets, but that's not what's happening. But what they want to do is maintain their fixed-income allocation, but within that allocation make some very important changes,” says Yariv Itah, partner at money manager consulting firm Casey, Quirk & Associates LLC, Darien, Conn.
“Now it could be that if there were to be two events that can reshuffle the deck. One is a sudden increase in rates and the other is inflation. As soon as that happens, then people are going to take another look at their portfolios and make that decision,” Mr. Itah said.
The massive success of core fixed income in the past decade has guaranteed a change in the way asset owners invest, according to Christopher Redmond, senior investment consultant and head of global bond manager research at Towers Watson & Co., London.
“Those managers who provided those funds, literally they reached sizes you could scarcely believe, hundreds of billions, guaranteeing a negative real return, so you've seen a rotation out of that into something that yields a bit more, alternative fixed income or equity, not surprising at all,” Mr. Redmond said. “We see it as unlikely (that) you see (a) wholesale shift out of investment-grade high-yield into equity. Most of those allocations are strategic diversity plays.”
To go directly from core fixed income to equities might be too great a leap of risk.
“It's a spectrum of risk,” says Michael Rosen, principal and chief investment officer at Angeles Investment Advisors LLC, Santa Monica, Calif., “and equities fall at the far end of that risk. Credit risk, even credit risk, is not the same as equity risk by orders of magnitude. To say we'll move from core fixed income to equities is a huge shift in risk. Less of a shift is moving from traditional fixed income into high-yield fixed income or bank loans or emerging markets debt or something like that. It's by degrees. It's striking that right balance.”
Few have taken that leap. One example of a fund that has made that move is the University of California Board of Regents' investment committee, which approved on May 20 a huge drop in its target allocation to fixed income to 20% from 65% in its $4.7 billion Total Return Investment Pool.
New allocations created as a result are almost entirely outside the credit or fixed-income realm: a 20% allocation to cross-asset-class strategies; 10% each to opportunistic equity, global REITs and absolute-return strategies; and 7.5% to emerging markets equity.
Marie N. Berggren, Oakland, Calif.-based chief investment officer, vice president-investments and acting treasurer of the University of California, told the investment committee at a meeting in Los Angeles that exposure to fixed income in the total return fund was too large given the low-interest-rate environment, according to a webcast of the meeting.
Pension funds, on the whole, however, have set up a system that takes into account the risk of more illiquid debt-related strategies.
“(Pension funds) been evaluating the amount of risk that they're comfortable in taking in terms of that asset/liability decision,” says Janine Baldridge, Russell Investments' managing director, alternative investment consulting practice, based in Seattle. “When you look in the return-seeking portfolio, the question is trading off equity risk against other opportunities to enhance returns in your return-seeking portfolio.” n
