ING Investment Management says that with government bonds yielding 1.5%, institutional funds are increasingly looking for alternatives that manage volatility while returning upwards of 3%.
Tim Dowling, Head of the Credit Boutique at ING Investment Management: “On the institutional side, portfolios have traditionally been built around a starting point of government bonds. But for pension funds and insurance companies investing your money in 1.5% yielding bonds is not really attractive. An insurance company’s business model cannot be run on that low a return and it needs to invest in assets yielding between 3-5%. Not only that, they are looking for low volatility which is why we now find institutional investors now looking to high yield.”
The investment manager notes that government bonds have benefited from a 30 year rally and tightening yields, suggesting that the bottom has now been reached. Accordingly, this has led to institutional investors being forced to make choices between capital protection, income and price appreciation.
Tim Dowling continues: “Government bonds historically used to cover all three bases however, at the moment, government bonds will only provide capital protection. For income, you need to look to other asset classes such as credit, EMD and so on. In terms of appreciation, the outlook for all asset classes has changed fundamentally although not so much for retail investors.
“Unlike retail investors, institutions have more funds with which to allocate and can spread their money in asset classes across the globe. We have seen institutions decreasing exposure to equities and government bonds while moving this investment into credit. It might be the case that these investors re-rotate back into equities although we don’t see much of that as yet.”
ING IM observes that a number of institutional investors are waiting for a further market correction before investing further in high yield assets. However, the investment manager believes that, going forward, there will be a growing movement towards being structurally overweight credits.
Looking ahead, ING IM believes that, given where current interest rates are and where they are expected to be in the medium term, credits will become the core of the portfolio for both institutional and wealthier investors.
Tim Dowling concludes: “Longer term interest rates are dependent on inflation, growth and also the level of short term rate rises and all of those three are low in Europe. Therefore, for the probability of interest rate rises in Europe remains limited however, it could be a different story in the US.”
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