Institutional investors ditching bonds for alternative exposures

18 Feb 2021

With research showing that institutional investors are shunning bonds, is the traditional equity/debt portfolio split heading for the history books?

Institutional investors have traditionally favoured bonds as a reliable income stream, but that could soon change, if new research is any indication.

Around half (51%) of asset owners globally plan to reduce their exposure to bonds this year, according to Managing Partners Group. A double whammy of rising default risks and climbing inflation is to blame as investors fear they are taking too much risk for the rewards on offer.  

Almost two in every three institutional investors (65%) expect the level of defaults in developed world corporate debt to rise this year. The research also found that two in every five asset owners expect the price of goods and services to increase this year, while 16% are “extremely concerned” that inflation could erode real yields on bonds in the next 12 months, with 48% “moderately concerned” and 22% “somewhat concerned”.

Of those surveyed, 42% expect to see no change, while 13% predict the prices of goods and services to fall.

In a 2021 outlook note, Morningstar’s James Gard said that when inflation is considered, government bond yields are negative in absolute and real terms.

The question is, if asset owners are dumping their bonds what are they moving into to earn regular and secure cash income?

The research shows that investors are switching to alternative investments, lured by inflation-beating returns which are uncorrelated to more mainstream asset classes.

Indeed, 68% are planning to switch to property, according to the research, while hedge funds (55%), investing in the secondary market for life insurance policies (52%) and commodities (45%) feature in investors plans as do equities (24%).

Only around a quarter intend to increase their exposure to bonds this year. It is a moot point, which from this list will fulfill the role normally occupied by bonds.

The move by institutional investors to reduce their bond exposure could be part of a trend of questioning the accepted traditional 60% in stocks and 40% in bonds modus operandi.

The fiscal stimulus pumped into economies in response to the damage caused by Covid-19 has skewed some parts of the investment picture meaning standard approaches are being questioned, at least for a time.

Yet the traditional benefits of holding bonds – diversification and as a hedge against volatility in equities – are not going to change, even in the current environment.    

Morningstar’s Gard notes, therefore, that bonds are ultimately a good tool for investors going forward. “For bond investors, the yield curve – which shows changing bond yields over time – is a more reliable guide to where interest rates and economic growth will look like in the coming years,” he added.

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