Institutions still see a place for fixed-income managers

Despite the low-interest-rate environment and government bond yields reaching record lows, large fixed-income managers are still positioned to see continued inflows from institutional investors and largely expect their business strategies to remain intact, bond experts and money management executives say.

There will still be demand for fixed-income strategies among institutional investors, whose investment objectives run the gamut from finding a source of income to managing heightened volatility during the coronavirus pandemic to implementing liability-driven investing in their portfolios.

David A. Hunt, president and CEO of $1.3 trillion PGIM Inc., Newark, N.J., said that low interest rates seen since the global financial crisis have "fueled a search for yield within fixed income," that has resulted in institutions "moving out of lower-yielding Treasuries into higher-yielding fixed-income products, whether corporates, high yield, bank loans, structured products or emerging markets debt (strategies)." PGIM Fixed Income had $920 billion in assets under management as of June 30 across its active fixed-income platform, which includes investment-grade credit, emerging markets debt, LDI, municipal and government bond strategies.

Since the emergence of COVID-19, PGIM has seen the search for yield "intensify," Mr. Hunt added.

"Overall, we believe that fixed income will continue to be part of the very much growing asset management industry," Mr. Hunt said, noting that demand for higher-yielding strategies should continue as long as rates stay low.

Additionally, as populations in developed countries grow older and more individuals reach retirement age, demand for fixed income is expected to increase, Mr. Hunt said.

On Sept. 16, the Federal Reserve signaled that interest rates would remain near zero through at least 2023.

Amid the low-rate environment, publicly traded money managers saw strong net inflows into fixed income during the second quarter of this year, with many investors taking shelter in the asset class in reaction to, and anticipation of, further market shocks.

BlackRock Inc., New York, for example, saw record quarterly net inflows of $57 billion in its iShares fixed-income exchange-traded funds during the second quarter, the firm reported during its earnings call. The money manager had $100.2 billion of total net inflows in the second quarter, of which $60.3 billion was derived from fixed-income products.

Matthew Steinaway, a senior managing director and chief investment officer for global fixed income, cash and currency at State Street Global Advisors, Boston, said in an interview the firm doesn't think that low interest rates will necessarily mean lower flows into fixed income.

Of note, fixed income can provide a source of liquidity, generate yield or be used as a liability hedge for LDI clients, he said.

"In the LDI context, I think there'd be a source of growth there because (clients may be thinking) we've had a long equity run and it's time to start locking down assets," by using an LDI glidepath, Mr. Steinaway continued.

SSGA had $3.05 trillion in AUM, including $476 billion in fixed income as of June 30, up 3.9% over the first quarter.

David G. Eichhorn, president and head of investment strategies at St. Louis-based institutional money manager NISA Investment Advisors LLC, said that "one inconvenient truth about fixed income is there is always a role for it in any rate environment."

"Yes, rates are very low by any standard … (but) at a high level, clients and asset owners can't put all their assets into risky asset classes," he noted.

As of June 30, NISA managed $246 billion in physical assets, which were predominately fixed income, and $168 billion in derivative notional value in separate account overlay portfolios, according to its website.

According to Mr. Eichhorn, most institutional investors fall into two broad camps as it pertains to their fixed-income objectives — either using strategies to dilute the volatility of return-seeking asset classes or using bonds as interest-rate hedging in defined benefit plans.

For investors falling in the second camp, many are determining "how many bonds should I hold to offset all of this interest-rate risk in my liabilities?" Mr. Eichhorn said. "If you are hedging something, you are not driven by a return objective per se."

Dean Ungar, vice president, senior credit officer at Moody's Investors Service Inc., New York, said there have been very good inflows into fixed income so far this year, including in the third quarter, excluding "some blips" in the market during the first quarter caused by the coronavirus pandemic.

"We're more concerned with the actively managed equity business (of money managers) because that's been under tremendous pressure," Mr. Ungar said.

Moody's is less concerned about the outlook for fixed income because "the Fed is a huge buyer of Treasuries and residential mortgage-backed securities. When you have a huge buyer, that's going to keep asset (prices) up," Mr. Ungar said.

Despite low bond yields, investor uncertainty about an economic recovery and the impact of the presidential election positions fixed income to still be "a safe haven and an island of security," Mr. Ungar added.

By vehicle type, money managers have had significant inflows into fixed-income mutual funds and ETFs, according to Brendan Powers, associate director, product development at Cerulli Associates Inc., Boston.

"In our perspective at Cerulli, despite the interest rate environment, there will be demand for fixed-income strategies among investors as they construct portfolios," Mr. Powers said. "We don't think the asset class will be significantly out of favor."

Despite significant withdrawals from both institutional and retail investors in March from fixed-income mutual funds and ETFs, the universe still posted positive investor flows year-to-date through Aug. 31.

From Jan. 1 to Aug. 31, taxable bond mutual funds had $76 billion in net inflows, while municipal bond mutual funds had $13.6 billion in net inflows, according to data from Cerulli. This was despite taxable bond mutual funds suffering $221 billion in net outflows in March alone, and municipal bonds in these vehicles experiencing $43 billion in net outflows during that month.

"The fact that they were able to recover to positive flows is significant for fixed income and indicates a fixed-income demand regardless of the interest rate level," Mr. Powers said, noting that the last eight months offer an "important measure" of how the low-rate environment may impact bond managers looking forward.

During January to August, taxable fixed-income ETFs saw net inflows of $133 billion. This was despite taxable bond ETFs experiencing $18 billion in net outflows in March, according to Cerulli data.

Jeffrey B. Stakel, a Stamford, Conn.-based principal for the Casey Quirk practice of Deloitte Consulting LLP, said that the firm has seen allocations to passive fixed-income strategies steadily increase over the last five years among both institutional and retail investors.

According to Mr. Stakel, while large fixed-income managers will face fee pressures, an industrywide trend, fixed-income specialists may have "more room to defend management fees."

"No matter where you play, there's going to be fee pressure. But where there is more room to generate alpha relative to a benchmark, there is a higher likelihood of preserving the fees," Mr. Stakel said, noting high-yield bonds, emerging markets debt and private credit strategies as areas where specialists may be able to defend higher fees.

Mr. Steinaway at SSGA, however, sees fee pressures resulting in the continued migration of assets into passive strategies.

"We're a large index manager in fixed income, but there's an underlying trend from active fixed income flows to index (flows). We think that could be accelerated because low yields don't leave a lot of room for fees for asset managers. As institutions are looking at their total return and net of fees, they'll use index (strategies) in their portfolios more," he said.

Core and core-plus fixed income are areas where he expects to see more institutions migrating a portion of their fixed-income portfolios to passive investing.