Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 403

Mind the bond/equity rebalancing gap

At the end of the first quarter of 2021, the MSCI World equity index had returned 55% (total return in USD) over 12 months, while the return of the Bloomberg Barclays Global Aggregate (bond) index was just 4.7%, giving equities a 48% outperformance (see Exhibit 1).

Rebalancing required

The quarter-on-quarter gap between equity and bond returns through the end of March 2021 was 9.2% compared to 12.4% in the previous quarter. The most significant change in the pattern of returns is that the equity outperformance over the last year came primarily in 2020, while the underperformance of bonds was greatest in the first quarter of 2021.

This divergence will require many institutional investors to rebalance their portfolios to attain their preferred allocation. This will be particularly true for insurance companies and pension funds that typically follow quite closely to a 50-50 split between bonds and equities in their allocations.

In the US, this split has rarely varied by more than a few percentage points and the allocation to corporate bonds and US Treasuries has been similarly stable (see Exhibit 2).

Given that equities generally outperform bonds over time, achieving this target allocation (instead of maximising total returns) inevitably requires redemptions from equities and purchases of bonds.

Indeed, since the GFC, institutional investors have bought bonds every year, but they bought equities only twice and then only in small amounts (see Exhibit 3).

No meaningful impact

What might we expect in terms of fund flows in the upcoming quarter as US insurance companies and pensions align their allocations with the allocations they had at the end of 2020?

Assuming funds flows in the first quarter of 2021 were the same as in the last quarter of 2020, and applying the relevant index returns to the existing asset base, in the absence of rebalancing, we estimate allocations to:

  • equities would be 0.4% above target
  • corporate bonds would be 0.3% below target
  • Treasuries would actually be in line (the decline in the value of the Treasury portfolio due to rising rates has largely been offset by new bond purchases).

To restore the allocations, US institutional investors would need to buy about USD11 billion in Treasuries, USD58 billion in corporate bonds and redeem USD69 billion in equities.

These figures are only a percentage of typical purchases and redemptions, so we do not expect a meaningful impact on the market from institutional investor portfolio rebalancing this quarter.

 

Daniel Morris is Chief Market Strategist at BNP Paribas Asset ManagementThis article was first published on 6 April 2021 on Investors’ Corner.

This information is issued by BNP PARIBAS ASSET MANAGEMENT Australia Limited ABN 78 008 576 449, AFSL 223418. The information published does not constitute financial product advice, an offer to issue or recommendation to acquire any financial product. You will need to seek your own advice for any topic covered in the article. Investing in specialised sectors is likely to be subject to a higher-than-average volatility due to a high degree of concentration, greater uncertainty because less information is available, there is less liquidity or due to greater sensitivity to changes in market conditions (social, political and economic conditions).

 


 

Leave a Comment:

RELATED ARTICLES

10 key investment themes for 2022

10 key themes for 2021

Don't invest just for yield: the smarter way to generate income

banner

Most viewed in recent weeks

2024/25 super thresholds – key changes and implications

The ATO has released all the superannuation rates and thresholds that will apply from 1 July 2024. Here's what’s changing and what’s not, and some key considerations and opportunities in the lead up to 30 June and beyond.

The greatest investor you’ve never heard of

Jim Simons has achieved breathtaking returns of 62% p.a. over 33 years, a track record like no other, yet he remains little known to the public. Here’s how he’s done it, and the lessons that can be applied to our own investing.

Five months on from cancer diagnosis

Life has radically shifted with my brain cancer, and I don’t know if it will ever be the same again. After decades of writing and a dozen years with Firstlinks, I still want to contribute, but exactly how and when I do that is unclear.

Is Australia ready for its population growth over the next decade?

Australia will have 3.7 million more people in a decade's time, though the growth won't be evenly distributed. Over 85s will see the fastest growth, while the number of younger people will barely rise. 

Welcome to Firstlinks Edition 552 with weekend update

Being rich is having a high-paying job and accumulating fancy houses and cars, while being wealthy is owning assets that provide passive income, as well as freedom and flexibility. Knowing the difference can reframe your life.

  • 21 March 2024

Why LICs may be close to bottoming

Investor disgust, consolidation, de-listings, price discounts, activist investors entering - it’s what typically happens at business cycle troughs, and it’s happening to LICs now. That may present a potential opportunity.

Latest Updates

Shares

20 US stocks to buy and hold forever

Recently, I compiled a list of ASX stocks that you could buy and hold forever. Here’s a follow-up list of US stocks that you could own indefinitely, including well-known names like Microsoft, as well as lesser-known gems.

The public servants demanding $3m super tax exemption

The $3 million super tax will capture retired, and soon to retire, public servants and politicians who are members of defined benefit superannuation schemes. Lobbying efforts for exemptions to the tax are intensifying.

Property

Baby Boomer housing needs

Baby boomers will account for a third of population growth between 2024 and 2029, making this generation the biggest age-related growth sector over this period. They will shape the housing market with their unique preferences.

SMSF strategies

Meg on SMSFs: When the first member of a couple dies

The surviving spouse has a lot to think about when a member of an SMSF dies. While it pays to understand the options quickly, often they’re best served by moving a little more slowly before making final decisions.

Shares

Small caps are compelling but not for the reasons you might think...

Your author prematurely advocated investing in small caps almost 12 months ago. Since then, the investment landscape has changed, and there are even more reasons to believe small caps are likely to outperform going forward.

Taxation

The mixed fortunes of tax reform in Australia, part 2

Since Federation, reforms to our tax system have proven difficult. Yet they're too important to leave in the too-hard basket, and here's a look at the key ingredients that make a tax reform exercise work, or not.

Investment strategies

8 ways that AI will impact how we invest

AI is affecting ever expanding fields of human activity, and the way we invest is no exception. Here's how investors, advisors and investment managers can better prepare to manage the opportunities and risks that come with AI.

Sponsors

Alliances

© 2024 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.