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

A tonic for turbulent times: my nine tips for investing

Investing is often portrayed as unapproachably complex. Can it be distilled into nine tips? An economist with 35 years of experience through numerous market cycles and events has given it a shot.

Rival standard for savings and incomes in retirement

A new standard argues the majority of Australians will never achieve the ASFA 'comfortable' level of retirement savings and it amounts to 'fearmongering' by vested interests. If comfortable is aspirational, so be it.

Dalio v Marks is common sense v uncommon sense

Billionaire fund manager standoff: Ray Dalio thinks investing is common sense and markets are simple, while Howard Marks says complex and convoluted 'second-level' thinking is needed for superior returns.

Welcome to Firstlinks Edition 467

Fund manager reports for last financial year are drifting into client mailboxes, and many of the results are disappointing. With some funds giving back their 2021 gains, why did they not reduce their exposure to hot stocks when faced with rising inflation and rates?

  • 21 July 2022

Welcome to Firstlinks Edition 466 with weekend update

Heard the word, cakeism? As in, 'having your cake and eating it too'. The Reserve Bank wants to simultaneously fight inflation by taking away spending power, while not driving the economy into a recession. If you want to help, stop buying stuff.

  • 14 July 2022

Welcome to Firstlinks Edition 465 with weekend update

Many thanks for the thousands of revealing comments in our survey on retirement experiences. We discuss the full results. And with the ASX200 down 10%, the US S&P500 off 20% and bond prices tanking, each investor faces the new financial year deciding whether to sit, sell or invest more.

  • 7 July 2022

Latest Updates

Economy

The paradox of investment cycles

Now we're captivated by inflation and higher rates but only a year ago, investors were certain of the supremacy of US companies, the benign nature of inflation and the remoteness of tighter monetary policy.

Shares

Reporting Season will show cost control and pricing power

Companies have been slow to update guidance and we have yet to see the impact of inflation expectations in earnings and outlooks. Companies need to insulate costs from inflation while enjoying an uptick in revenue.

Shares

The early signals for August company earnings

Weaker share prices may have already discounted some bad news, but cost inflation is creating wide divergences inside and across sectors. Early results show some companies are strong enough to resist sector falls.

Property

The compelling 20-year flight of SYD into private hands

In 2002, the share price of the company that became Sydney Airport (SYD) hit 80 cents from the $2 IPO price. After 20 years of astute investment driving revenue increases, it sold to private hands for $8.75 in 2022.

Investment strategies

Ethical investing responding to some short-term challenges

There are significant differences in the sector weightings of an ethical fund versus an index, and while this has caused some short-term headwinds recently, the tailwinds are expected to blow over the long term.

Investment strategies

If you are new to investing, avoid these 10 common mistakes

Many new investors make common mistakes while learning about markets. Losses are inevitable. Newbies should read more and develop a long-term focus while avoiding big mistakes and not aiming to be brilliant.

Investment strategies

RMBS today: rising rate-linked income with capital preservation

Lenders use Residential Mortgage-Backed Securities to finance mortgages and RMBS are available to retail investors through fund structures. They come with many layers of protection beyond movements in house prices. 

Sponsors

Alliances

© 2022 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. Any general advice or ‘regulated financial advice’ under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892) and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). 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.