Passive investing set to impact Treasuries market
Skip to main content
pilogo-NEW
Subscribe
  • Subscribe
  • My Account
  • login
  • NEWS
    • Asset owners and the coronavirus
    • Alternatives
    • Consultants
    • Coronavirus
    • Defined Contribution
    • ESG
    • Frontlines
    • Hedge Funds
    • Investing / Portfolio Strategies
    • Money Management
    • Pension Funds
    • People Moves
    • Private Equity
    • Real Estate
    • Searches & Hires News
    • SECURE Act
    • Special Reports
    • WorldPensionSummit
    • Ron Schmitz
      Pandemic drives faster transition for Virginia to private markets
      Mubadala Investment Co. logo
      Mubadala draws on portfolio in coronavirus fight
      T.J. Carlson
      Texas Muni reduces downside risk during pandemic, finding opportunities now
      Scott Davis
      ‘Triage plan’ at Indiana system helped stem losses
    • Walker & Dunlop appoints managing director
      Digital Alpha raises more than $1 billion for infrastructure fund
      John Haggerty
      Sector’s risks need to be weighed, consultant says
      A healthcare worker provides care for a COVID-19 patient in the intensive care unit at the Saint Joseph hospital in Marseille, France, on Nov. 20, 2020.
      Private equity’s health-care role draws spotlight
    • Philip Pearson
      Hymans Robertson chooses head of LGPS investment
      Daniel Celeghin
      Indefi hires New York-based managing partner
      Hub International continues buying spree with IBG acquisition
      Callan brings on 2 executives
    • American flags outside the New York Stock Exchange
      Stock shorts collapse as no hedge fund wants ‘head ripped off’
      Michelle Dunstan
      Move to link exec pay to ESG integration growing
      The J.P. Morgan Chase logo displayed at a branch bank
      J.P. Morgan sells $13 billion of bonds in largest-ever bank deal
      John Bakarat
      Commentary: COVID-19 and real estate debt – where investors should be looking
    • Pentegra joins with EPIC to offer 3(16) fiduciary services
      Interest rises in keeping retiree assets in-plan
      Joseph Healy
      Smaller DC plans place greater focus on improving financial wellness efforts
      Pentegra launches pooled employer plan
    • Pension funds hear from beneficiaries on ESG – report
      Ivanhoe Cambridge sets 2040 net-zero carbon goal
      Church Commissioners set 25% emissions reduction target by 2025
      U.S. likely to join Europe in mandating climate risk disclosure – John Kerry
    • Girls Who Invest
      MetLife plans 3 internships for Girls Who Invest scholars
      Model home
      Resmark sees niche in buying, leasing model homes
      Riscura stories
      Dystopian tales explore altered retirement reality
      Joel Holsinger
      Ares wants to do good – and profit – with fund
    • Karen Karniol-Tambour
      Bridgewater appoints 2 co-CIOs to oversee new sustainable investing group
      Hedge funds post best first-quarter return since 2000
      Jason Kephart
      Managers see good times ahead in 2021
      Jev Mehmet, CEO of Brevan Howard's Coremont unit
      Brevan Howard runs $50 billion unit like BlackRock’s Aladdin
    • Chinese stock risk up in first quarter, U.K. risk down – Qontigo research
      First Eagle starts small-cap equity team with liftout from Royce
      Sacramento County Employees rebalances equity, fixed-income portfolios
    • First Eagle starts small-cap equity team with liftout from Royce
       Kaitlin M. May
      Putnam Investments names head of global institutional management
      Paul Griffiths
      HSBC Asset Management selects next global head of institutional business
      Alex Bernhardt
      BNP Paribas AM picks global head of sustainability research
    • State pension plan funding advances in first quarter – Wilshire
      Sacramento County Employees rebalances equity, fixed-income portfolios
      CAAT pension plan scores 11.1% gain in 2020
      The headquarters of the California Public Employees' Retirement System, Sacramento
      CalPERS board votes to add long-term comp for CIO post
    • Walker & Dunlop appoints managing director
      First Eagle starts small-cap equity team with liftout from Royce
      Philip Pearson
      Hymans Robertson chooses head of LGPS investment
       Kaitlin M. May
      Putnam Investments names head of global institutional management
    • European private equity deal value, volume hit records for first quarter
      Paul Morrissey
      Blackstone Growth picks managing director to lead European investing
      Bills of euro, dollar and pound currencies, among others
      Ardian closes latest buyout fund at $8.8 billion
      Hand typing on stationary iPhone at an office reception desk
      Private equity’s taste for tech spurs $80 billion deal spree
    • BentallGreenOak closes latest European fund at $2.3 billion
      Cohen & Steers adds team for new private real estate business
      Australia’s Centuria makes takeover bid for Primewest
      CalSTRS indutrial property
      Investors hungry for industrial properties
    • Andy Schreiner
      New PEPs targeting firms without retirement plans
      Jackie Walorski
      Contribution catch-up for caregivers gaining favor
      Retirement cartoon
      Hopes rising for retirement readiness in 2021
      Neal and Brady
      Retirement security could be only issue both sides accept
    • A coin representing Bitcoin cryptocurrency in the U.K.
      Cryptocurrency and digital assets
      Corporate pension contributions
      Eddy Awards 2021
      COVID-19: One year in
    • U.S. still a key market for investors
      Collected coverage of P&I's 2020 WorldPensionSummit
      Pedestrians pass a large advertisement on the Arndale Center shopping mall reading 'Act now to avoid a local lockdown' in Manchester, England
      COVID-19 puts new opportunities and risks on the agenda - WPS panelists
      Screens display stock price information over the trading floor of the NYSE Euronext exchange in Paris
      Private assets will continue to grow in portfolios – WPS panelists
  • Data
    • Research Center
    • Searches & Hires Database
    • Searches & Hires News
    • RFPs
    • Charts / Infographics
    • Sponsored Research
    • Trackers
    • Q2 2020 searches and hires overview report
      Q2 2020 money manager M&A activity summary
      Q2 2020 legal overview report
      Q1 2020 searches and hires overview report
    • Chicago Policemen on lookout for passive manager
      Iowa Public Employees seeks investment consultant
      New York State Common slates $400 million for renewable energy
      Texas County commits $100 million to another Taconic credit fund
    • Chicago Policemen on lookout for passive manager
      Iowa Public Employees seeks investment consultant
      New York State Common slates $400 million for renewable energy
      Texas County commits $100 million to another Taconic credit fund
    • Emerging Market Debt Manager Services
      Real Assets Consultant
      Passive Investment Management Services
      Active Extended Global Credit Manager Search
    • High-yield spreads narrow, default rates drop
      Private real estate funds continue rebound
      Managed account adoption stalls in 2020
      U.S. bonds have worst quarterly return since 1981
    • Institutional Investors: Shared Expectations, Divergent Paths
      Global Investor Study 2016
      Workplace Financial Wellness
    • U.S. Endowment Returns Tracker
      Pension Fund Returns Tracker
      Earnings Tracker
      Corporate Pension Contribution Tracker
  • Insights
    • Opinion
    • White Papers
    • Industry Voices
    • Letters to the Editor
    • Partner Content
    • Publisher's Update
    • Marcie Frost
      CalPERS: Urgency underscores all areas of providing retirement security
      BPTW cartoon
      P&I’s Best Places to Work marking a milestone
      CalPERS cartoon
      Urgency underscores CalPERS' search for a CIO
      Multiemployer plans cartoon
      Money — but no fixes — for multiemployer plans
    • Bipsync Client Stories: RMS in Action at Pensions and Superannuation Funds
      COVID-19 Makes LP Portfolio Management More Important Than Ever
      China: the outlook is bright for longer-term investors
      Finding Differentiation in Securitized Assets
    • John Bakarat
      Commentary: COVID-19 and real estate debt – where investors should be looking
      Jake Remley
      Commentary: Inflation expectations vs. reality in the bond market
      Greg Shea and Steven Kindred
      Commentary: The solution for yield-seeking allocators may be hiding in plain sight
      Jim Park
      Commentary: Asian Americans, Pacific Islanders face ‘bamboo ceiling’ in money management
    • Marcie Frost
      CalPERS: Urgency underscores all areas of providing retirement security
      Writer using a typewriter
      OCIO industry needs to adopt GIPS
      Writer or journalist workplace. stock illustration
      Even as it assails China, Trump administration emulates it
      Skeptical of Main Street support for proxy adviser proposal
    • P&I Content Solutions
      Research for Institutional Money Management
      P&I Content Solutions
      Top questions for institutional investors
      Sponsored Content By Newton Investment Management
      Growth and Innovation in Emerging Markets
      P&I Content Solutions
      In Challenging Markets, Systematic Global Macro Strategies Could Hold Opportunity
    • Help us help you by supporting quality journalism
      You Must Believe in Spring
      Everything Must Change
      Tomatoes & Investments
  • Multimedia
    • Videos
    • Webinars
    • Polls
    • Slideshows
    • Charts / Infographics
    • Invesco logo shown on the floor of the New York Stock Exchange
      watch video
      1:28
      Invesco’s bid for performance gains
      watch video
      1:23
      The passive fixed-income glut
      watch video
      1:38
      Is it time for DC plans to embrace private equity?
      watch video
      5:39
      The coronavirus pandemic: One year later
    • New Outlook on Income: A Framework for Evaluating DC Retirement Income Solutions
      Investing in infrastructure at the right price
      Time for Action: Shifting Pension Dynamics from a Macro and Regulatory Relief Perspective
      Understanding the PEP Evolution
    • POLL: Cryptocurrency investing
      POLL: The Biden infrastructure plan
      POLL: Retirement income solutions
      POLL: Working after the pandemic
    • view gallery
      9 photos
      Coronavirus and the markets
      view gallery
      22 photos
      The 1,000 largest retirement funds: 2020
      view gallery
      10 photos
      Outlook 2020
      view gallery
      10 photos
      2019 as seen through the eyes of Roger
    • High-yield spreads narrow, default rates drop
      By the Numbers for April 2021
      Graphic: The state of DC plans
  • Events
    • Conferences
    • Webinars
    • DC Investment Lineup Virtual Series
      ESG Investing Virtual Series
      Private Markets Virtual Series
      Retirement Income Conference
    • New Outlook on Income: A Framework for Evaluating DC Retirement Income Solutions
      Investing in infrastructure at the right price
      Time for Action: Shifting Pension Dynamics from a Macro and Regulatory Relief Perspective
      Understanding the PEP Evolution
  • Careers
  • Research Center
MENU
Breadcrumb
  1. Home
  2. INVESTING & PORTFOLIO STRATEGIES
March 14, 2017 01:00 AM

Passive investing set to impact Treasuries market

Adam Phillips
  • Tweet
  • Share
  • Share
  • Email
  • More
    Reprints Print

    The move toward the automation of a greater percentage of our lives — think the Amazon Echo's Alexa — has a parallel in the investing world.

    Consider this trend in light of the fourth quarter of 2016, the worst quarter for the broad U.S. bond market since 1981. After a nearly 100-basis-point rise in Treasury yields resulting in a nearly 3% decline for the quarter, investors are faced with new opportunities and challenges. Between rising expectations of growth and inflation, the broad market yields ended 2016 at their highest level (2.6%) in five years, presenting an attractive investment environment. At the same time, benchmark duration has risen to the highest levels (5.9 years) since its inception in 1973 and 30% above the level 10 years ago (4.5 years), which presents new challenges to fixed-income investors.

    Against this duration and yield backdrop, and with the growing trend of automation, we contemplate how the growth of passive investing has affected not just the investors choosing a passive approach, but the overall U.S. fixed-income landscape. In observing this trend, examining both index construction and the issuance of securities, we find Treasuries are the fixed-income sector most impacted by the growth of passive investing.

    Uncle Sam says thanks

    At the end of 2016, the most standard fixed-income benchmark, the Bloomberg Barclays Aggregate Bond index, the “Agg,” had a 36% weighting to Treasuries. By contrast, the average allocation to U.S. Treasuries for funds in the Morningstar Intermediate Term Bond category (the largest and broadest taxable bond category) was 18%. Interestingly, that category includes passive funds as well, suggesting that generally active managers have less than half the allocation to Treasuries compared to the index. That ratio is significant as 90% of flows into the taxable bond category as measured by the Morningstar DirectSM U.S. Asset Flows Update in the past three years have gone into passive funds.

    These flows have increased investment in passive fixed-income strategies from less than 20% of taxable bonds to nearly 30% over that time period. The increase is both large and, with the differential sector allocation, impactful both for the investors making the allocation and the fixed-income landscape writ large. As such, it appears that an underappreciated source of support for U.S. rates the past few years has been the increase in passive investing.

    Although one cannot necessarily extrapolate from this trend that either the shift toward passive investing or overall flows into the asset class will continue, for investors, the factor risk of rates is higher in a passive approach.

    Fighting the Fed

    Further examining the impact of the passive trend on Treasuries, we delve into the construction of the index for its treatment of government securities. The rules for inclusion in the Agg exclude “U.S. Treasuries held in the Federal Reserve” System Open Market Account. This rule has been in place for a long time, but was designed when the Fed balance sheet was a fraction of its current size and focused on shorter maturity securities. The rule seems logical enough as it removes from the index allocation bonds that the Fed has effectively removed from circulation.

    However, as the Fed SOMA has been particularly active since the financial crisis, the amount of Treasury notes and bonds held by the Fed has grown significantly. For context, the entirety of the Treasury allocation in the Agg is $6.75 trillion, meaning the approximately $2.3 trillion held by the Fed equates a quarter of Treasury notes and bonds (on a notional basis) being excluded from the index. Were those holdings not excluded from the index (or when the Fed eventually eliminates those holdings), the index's allocation to Treasuries would rise about 7 percentage points to almost 44% of the index. While the support for the securitized sectors is even more dramatic at nearly one-third of issuance ($1.8 trillion) of the $5.6 trillion in the Agg held by the Fed, these securities are not removed from the Agg, only from the float-adjusted version of the index.

    Further, the Fed has been remitting the interest on its balance sheet, approximately $100 billion a year, to the Treasury department over the last several years. As those securities roll off and interest payments are no longer collected by the Fed, the Treasury will have a larger deficit to contend with presumably through the issuance of additional Treasuries. And this is before any new fiscal policy and infrastructure projects now under discussion.

    We are not projecting the Fed will begin eliminating those holdings near term, but at some point they will cease their reinvestment of the maturing principal. When that occurs, the newly available Treasuries will be entering the market and passive investors will be actively allocating a higher percentage to Treasuries, just as the Fed withdraws support from that segment of the market. Contrary to the investment adage of our times, “don't fight the Fed,” it appears passive investment strategies are set to do just that.

    Indexes are like a box of chocolate …

    Similarly, the index's flexibility on other guidelines opens the possibility of new and perhaps unexpected securities entering the index. For example, with chatter since the election of introducing long-dated Treasuries, the question of the natural buyer for 50- and 100-year bonds arises. In addition to the two general categories of significant buyers we would normally expect, those in a liability-matching programs and yield seekers, we would add another potential buyer: passive investors.

    Passive investing in fixed income tends not to mirror index holdings, rather using sampling techniques to emulate the risk factors of the index. Given the somewhat unique nature of these potential long Treasuries, some combination of these securities might need to be purchased to capture those factor attributes in the passive approach.

    As the Treasury has been keen to maintain the liquidity of Treasuries, the start of such a program is not likely to be a one-off event. A built-in and growing buyer base for such issuance may encourage the Treasury to proceed.

    In the land of the passive, the one eyed man(ager) is king

    In anticipating the Fed's eventual normalization of policy and decrease in support for markets, we ponder these effects on the market broadly. The trend to passive investing has an underappreciated importance in this scenario given index construction rules.

    The addition of Treasuries as the Fed reduces exposure is not necessarily the market call we expect most passive investors are looking to make. Interestingly, the built-in buyer for these securities gives the Fed more freedom to withdraw support, knowing their actions are less disruptive today than prior to the growth of passive investing. Should the trend toward passive investing continue or accelerate, the Fed's ability to offload securities to those not necessarily seeking that exposure strengthens.

    The biggest paradox of all then, is that the Fed and active bond investors might benefit from the trend to passive investing. Passive investors may cushion the blow for other fixed-income investors, purchasing more securities as they are released into the market, providing an unexpected buyer whose absence might otherwise have led to a more rapid increase in rates. This buying by passive investors could aid the orderly wind down of the Fed balance sheet, while those seeking to eschew an active market call through index exposure may stand against the Fed.

    Conclusion

    The phenomenon of passive investing in fixed income has had and continues to have a significant impact on the overall landscape for the bond market. This impact goes beyond the individual investors electing passive strategies and touches on some of the most central issues in fixed income today.

    With the continued increase in benchmark duration, new securities potentially being introduced into the market and the eventual wind down of the Fed balance sheet lingering, questions regarding bond market positioning become more poignant. Addressing these questions requires nimbleness, creativity and expertise.

    Adam Phillips is senior client portfolio manager with Taplin, Canida & Habacht LLC, an investment team of BMO Global Asset Management in Miami.

    This content represents the views of the author. It was submitted and edited under P&I guidelines, but is not a product of P&I's editorial team.

    Related Articles
    Hedge fund fees – a perfect solution
    Policy shifts won't stop bond market evolution
    Firms at the crossroads: Offer alpha or disappear
    Passive investment train overtakes active
    Will any QDIA do? Fiduciary duty says otherwise
    Target-date funds: Same destination, different (glide)paths
    Treasuries rally after U.S. drops huge non-nuclear bomb on IS
    As rates rise, investors scramble to lock in gains
    Indexing and the evolution of active management
    Treasury calls for systemic risk designation leader at FSOC, Volcker changes in…
    Playing the long game: The case for ultralong Treasuries
    Recommended for You
    More funds testing water on crypto-related assets
    More funds testing water on crypto-related assets
    Money managers eager to make leap to opportunity zone investing
    Money managers eager to make leap to opportunity zone investing
    Index investing: Not as passive as you might think
    Index investing: Not as passive as you might think
    Innovations in DC: Helping Supercharge Retirement Outcomes
    Sponsored Content: Innovations in DC: Helping Supercharge Retirement Outcomes
    sponsored
    Events
     
     
    Sponsored
    White Papers
    Bipsync Client Stories: RMS in Action at Pensions and Superannuation Funds
    COVID-19 Makes LP Portfolio Management More Important Than Ever
    China: the outlook is bright for longer-term investors
    Finding Differentiation in Securitized Assets
    Green and sustainable bonds in emerging markets
    Portfolio Protection: One Size Fits None
    View More
    Sponsored Content
    Partner Content
    The Industrialization of ESG Investment
    For institutional investors, ETFs can make meeting liquidity needs easier
    Gold: the most effective commodity investment
    2021 Investment Outlook | Investing Beyond the Pandemic: A Reset for Portfolios
    Ten ways retirement plan professionals add value to plan sponsors
    Gold: an efficient hedge
    View More
    E-MAIL NEWSLETTERS

    Sign up and get the best of News delivered straight to your email inbox, free of charge. Choose your news – we will deliver.

    Subscribe Today
    April 5, 2021 Page One

    Get access to the news, research and analysis of events affecting the retirement and institutional money management businesses from a worldwide network of reporters and editors.

    Subscribe
    Connect With Us
    • RSS
    • Twitter
    • Facebook
    • LinkedIn

    Our Mission

    To consistently deliver news, research and analysis to the executives who manage the flow of funds in the institutional investment market.

    pilogo-NEW
    About Us

    Main Office
    685 Third Avenue
    Tenth Floor
    New York, NY 10017-4036

    Chicago Office
    150 N. Michigan Ave.
    Chicago, IL 60601

    Contact Us

    Careers at Crain

    About Pensions & Investments

     

    Advertising
    • Media Kit
    • P&I Content Solutions
    • P&I Careers | Post a Job
    • Reprints & Permissions
    Resources
    • Subscribe
    • Newsletters
    • FAQ
    • P&I Research Center
    • Site map
    • Staff Directory
    Legal
    • Privacy Policy
    • Terms and Conditions
    • Privacy Request
    Pensions & Investments
    Copyright © 1996-2021. Crain Communications, Inc. All Rights Reserved.
    • NEWS
      • Asset owners and the coronavirus
      • Alternatives
      • Consultants
      • Coronavirus
      • Defined Contribution
      • ESG
      • Frontlines
      • Hedge Funds
      • Investing / Portfolio Strategies
      • Money Management
      • Pension Funds
      • People Moves
      • Private Equity
      • Real Estate
      • Searches & Hires News
      • SECURE Act
      • Special Reports
      • WorldPensionSummit
    • Data
      • Research Center
      • Searches & Hires Database
      • Searches & Hires News
      • RFPs
      • Charts / Infographics
      • Sponsored Research
      • Trackers
    • Insights
      • Opinion
      • White Papers
      • Industry Voices
      • Letters to the Editor
      • Partner Content
      • Publisher's Update
    • Multimedia
      • Videos
      • Webinars
      • Polls
      • Slideshows
      • Charts / Infographics
    • Events
      • Conferences
      • Webinars
    • Careers
    • Research Center