As yields on top-rated sovereign and even corporate bonds dwindle and disappear, investors who have long relied on that steady, guaranteed income stream are taking bigger gambles to achieve a reasonable level of returns for their clients. Keen to stay in the broad fixed-income universe rather than move into other asset classes like equities or "alternative" investments such as hedge funds, they are taking on more risk by buying less liquid bonds or debt with a lower credit rating.
This applies to a wide range of investors, from pension funds to central banks, who are finding it increasingly difficult to make money in an environment of deflation, zero interest rates and evaporating bond yields. "Conversations with clients about changing mandates started about 18 months ago, but they have definitely picked up in the last quarter," said April LaRusse, senior fixed income product specialist at Insight Investment, an asset manager owned by Bank of New York Mellon with 363 billion pounds of assets under management.
"This has been on investors' minds for some time, but given how low yields are now, we're expecting these conversations to become more frequent." Money managers are increasingly rethinking their strategies, something they have been doing since central banks first started slashing interest rates to zero and introducing bond-buying "quantitative easing" programs in response to the 2007-08 global financial crisis. Pension fund assets at the end of last year were worth 84 percent of global gross domestic product compared with 54 percent in 2008, according to research firm Towers Watson.
Of that $42 trillion pile, defined contribution assets accounted for 38 percent and should overtake defined benefit assets in the coming years. That suggests investors' scramble for yield will get even more intense than it already is. The problem of lower returns has become even more acute thanks to the 50 percent collapse in oil prices in the last half of 2014. This drove down inflation and with it bond yields, which have gone from ultra-low to negative in some cases.
Some $7.3 trillion of government bonds and bills around the world provide a negative yield, according to Bank of America Merrill Lynch calculations. All German government bond yields out to six years maturity and all Swiss bonds out to 10 years maturity are negative. Even the yield on Swiss chocolate-maker Nestle's 10-year bonds briefly went negative last month.
But changing investment mandates isn't done lightly or quickly. The client will discuss the mandate, then decide to change and go through the alternative investments with the money manager, who will then liquidate funds and implement the new strategy. This typically takes months. But the pressure is building. Figures this week showed that the shortfall in Britain's private sector pension plans rose to a record 367.5 billion pounds ($559.59 billion) at the end of January. The total assets under management of 6,057 schemes tracked by the Pension Protection Fund (PPF) index were 1,274 billion pounds, while liabilities stood at 1,641 billion pounds. More than 5,000 schemes were in deficit, the watchdog said.
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