Gross urges speeding up global bond allocations

Institutional investors increasingly are thinking outside the U.S. Barclays Capital Aggregate box for their fixed-income allocations, but market veterans say that it will be a long time before there are more-global mandates
APR 05, 2011
Institutional investors increasingly are thinking outside the U.S. Barclays Capital Aggregate box for their fixed-income allocations, but market veterans say that it will be a long time before there are more-global mandates. Bond guru Bill Gross, the co-chief investment officer of Pacific Investment Management Co. LLC, in his February investment outlook urged investors to pick up the pace. Arguing that the prevailing U.S. low-interest-rate policy amounts to “robbing savers” — from the man on the street to pension funds — he said that investors might want to “exorcise” U.S. Treasury bonds from their portfolios in favor of better risk-reward trade-offs in credit or emerging-markets debt. The precarious fiscal state of the U.S. government is prompting that review of bond allocations. About 80% of the BarCap Aggregate is tied to the U.S. government, and a continued rise in U.S. debt will leave investors who use that market-cap-weighted index more exposed to a single, increasingly strained sovereign risk, said Erik Knutzen, CIO of investment consulting firm NEPC LLC. He said that his team is urging clients to “disaggregate the Agg” — to look at the underlying betas to which they are exposed, while freeing themselves from the constraints of that widely used benchmark. A number of bond veterans are reaching similar conclusions. There is a growing sentiment that institutional investors should “bag the Agg,” because elements of a BarCap Aggregate-indexed core bond portfolio “may not be what investors want or need,” said Matthew Toms, a senior vice president and head of U.S. public fixed-income investments for ING Investment Management. He said that kind of soul-searching is prompting growing interest in “more creatively designed benchmarks,” more global in nature, to complement the BarCap Agg. Pimco offered one alternative in the summer of 2009: its Global Advantage Bond index, which weights allocations by gross domestic product rather than by the market capitalization of outstanding debt. Last year, Research Affiliates LLC introduced fundamentally weighted investment-grade-bond and high-yield-bond indexes. It plans to unveil global-sovereign and emerging- markets fundamental indexes, weighted by gross domestic product, population, land mass and energy use as proxies of factors of production, said Robert D. Arnott, the company's chairman and chief executive. Some key segments of the institutional market already have moved on, observers said. A growing number of corporate defined-benefit plans, for example, have dropped the BarCap Agg as they have adopted liability-driven investment programs with longer-dated bonds. Likewise, endowments and foundations were never big users of the index. Still, public funds and Taft-Hartley plans continue to use the BarCap Agg, whose dominance is being challenged on the periphery, market veterans said. There is no obvious alternative benchmark for core institutional allocations, but concerns about an eventual rise in interest rates have made traditionally conservative in-vestors willing to put more money into strategies with considerable tracking error to that index, said Jae Park, CIO of fixed income with Loomis Sayles & Co. LP. Core and core-plus portfolios benchmarked to the BarCap Agg always will have a place in U.S. pension plans, but increasingly, they will share pride of place with more global allocations, including emerging- markets debt and opportunistic, absolute-return-oriented strategies, said David Leduc, the CIO of active fixed income with Standish Mellon Asset Management Co. LLC. That interest in further diversification has led to growing allocations over the past year or two for areas such as high-yield bonds, emerging-markets debt and bank loans. Market veterans said that the biggest momentum over the past year was to emerging-markets debt, with a considerable pickup in flows from a small base. Peter Wilby, CIO of credit and emerging-markets-debt boutique Stone Harbor Investment Partners LLP, said that his firm garnered 75 emerging-markets-debt mandates last year, with combined inflows of $5.2 billion. After a strong year or two for credit and emerging-markets debt, the coming year could prove a bit trickier for investors looking to funnel additional money into those market segments. “We're not hitting the eject button,” but it wouldn't be wise to expect another year of outsize returns from high-yield bonds or emerging- markets debt, said Keith Lewis, head of institutional sales for North America with T. Rowe Price Group Inc. Whether there is a temporary lull in allocations, some observers insist that the strategic imperative behind boosting non-U.S. bond exposure remains compelling longer-term. A number of institutional investors are playing catch-up, but for the most part, they remain drastically underweight in emerging-markets debt, said Cynthia Steer, managing director of investment strategy with Russell Investments. Although some investors have put 2% or so of their portfolios into emerging-markets debt, a 6% to 10% allocation would reflect a more accurate appreciation of how the world is changing, she said. There will be a further acceleration in allocations to non-dollar portfolios this year, both for developed and emerging markets, said James Flick, director of global client service and marketing at Western Asset Management Co. Western's own book of business for the most recent quarter reflected that trend, with executives reporting outflows from core and core-plus strategies, but a healthy rise to about $4 billion in mandates won but not yet funded to more-specialized fixed-income strategies, including $1.6 billion to liability-matched U.S. credit; $930 million in global mandates; $835 million in emerging-markets mandates and $335 million in non-U.S. regional mandates. A number of market veterans likewise predict growing interest for unconstrained, multisector absolute-return-bond strategies. The growing demand for “go-anywhere” strategies and the “opportunistic” allocations being carved out by some plan sponsors reflect a “lack of comfort relying on traditional ways of setting strategic asset allocation” in today's economic environment, said John Pirone, lead strategist for BlackRock Inc.'s Multi-Asset Client Solutions group. “We're in an environment now where the ability to be nimble may be a good thing,” Mr. Lewis said. He said that T. Rowe's Global Multi Sector bond mutual fund, which has a two-year track record, has attracted considerable interest, and once it achieves a three-year record, the firm will pursue institutional investors as well. Kevin Kearns, a portfolio manager of two absolute-return strategies launched in recent months by Loomis Sayles, said that his firm already is finding institutional investors open to looking at those new offerings, including an Absolute Strategies bond fund launched Dec. 15, with a global mandate and ability to short, that aims to deliver a 6% to 7% annual absolute return over a market cycle. The flexibility that these strategies offer to pursue value in any sector of the global bond market, combined with the ability to short areas seen as overvalued, could come in handy in this highly unstable economic environment, observers said. The biggest offering in that segment right now, Pimco's Unconstrained Bond strategy, has $14.5 billion in U.S. mutual fund assets, $8.6 billion of which was in the fund's institutional share class, as well as $1.2 billion in institutional separate accounts. As of Jan. 31, the fund's positions included a 42% short position in government-related debt, with 91% in cash, 16% in mortgages, 15% in investment-grade credits and 11% in emerging markets, as well as a negative bet on duration. Douglas Appell is a reporter at sister publication Pensions & Investments.

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