Large asset management groups are piling back into fixed income to lock in the higher yields on offer after a “cataclysmic” period of performance for bonds last year.
A steep rise in US interest rates over the past 12 months sent bond prices tumbling but has now left yields on Treasury notes higher than they have been for most of the past decade. With the Federal Reserve close to the end of its tightening cycle, institutional and retail investors are buying both sovereign and corporate bonds.
“Bonds are exciting again, for the first time in a long time. They were boring with zero rates for several years,” Sebastien Page, chief investment officer of T Rowe Price’s global multi-asset strategy, told the Financial Times.
“It’s very simple — yields are much higher than they were and it just means you have higher expected returns,” added Page, who likes high-yield corporate bonds.
More than $332bn flowed out of active fixed income strategies in the US last year, according to Morningstar data. But the tide has now turned and more than $100bn has poured into fixed income funds during the first four months of this year.
Managers are equating the shift in capital into fixed income with the scale of the movement of assets from actively managed funds into lower-cost passive funds that track an index, a shift over the past decade that has fundamentally reshaped the asset management sector.
“We’re seeing enormous moves into fixed income,” said Yie-Hsin Hung, the chief executive of $3.6tn-in-assets State Street Global Advisors at the Milken Institute conference earlier this month, noting large flows into bond exchange traded funds and passive funds. “It feels like the beginning stages of what happened in equities, moving much more into passive.”
Mike Gitlin, chief executive of Capital Group, which manages $2.2tn in assets, told the conference that, due to the higher interest rate environment “we’re seeing an average of $500mn in net new flows into the bond markets at Capital Group per week”.
“I think you’ll see $1tn flow back into the bond market in the next few years,” he added. “I think it’s coming and I think you’ll see it accelerate.”
Part of the shift in enthusiasm is down to the fact that bonds performed so badly last year. The yield on the two-year US Treasury, which moves with interest rate expectations, rocketed from 0.7 per cent to 4.4 per cent while the 10-year yield jumped from 1.5 per cent to 3.8 per cent. The bonds now yield 4.2 per cent and 3.6 per cent respectively. Bond prices fall as yields rise.
“2022 was cataclysmic for fixed income. It was by some measures, the worst year on record,” said T Rowe Price’s Page.
The ability to generate high yields while taking relatively low levels of risk is set to allow more traditionally risk averse investors — such as those who handle retirement savings — to allocate into the space. “Finally people can allocate to fixed income and get a return. You could have one-third of your pension fund in fixed income and still hit your target,” said Franklin Templeton chief executive Jenny Johnson on an earnings call earlier this month.
Investors are betting the Fed may be forced to cut interest rates as soon as this year. Asset managers have the largest long position — a bet that prices will go up and yields will come down — in two-year Treasury notes this year, according to data from the Commodity Futures Trading Commission.
“We think as interest rates calm in the market, we feel like there will be one more raise and then sit there through 2023, and probably not have a decrease,” said Johnson. “People will try to lock in those higher rates.”
However, she added that not all fixed income is set to yield outsized returns this year, and active selection of bonds will become more crucial. “It’s an important time to be active in the fixed income space. This is not a great time to be passive in it.”
Asset managers say that actively managed fixed income has also become a preoccupation for their clients after years of credit being a relatively quiet part of their portfolio. “We have seen a significant uptick in interest from clients,” said Eric Burl, the head of discretionary at Man Group in the UK.
“The utility of fixed income in your portfolio has completely changed . . . It’s not just that you can make equity like returns, but that’s clearly part of it,” said Page at T Rowe Price.
“It’s a time to be more active rather than less,” he said. “Now’s not the time to own the entire market.”