Fixed income is once again firmly in focus for asset allocators, with European and Asian gatekeepers revealing strong expected demand for the asset class over the coming 12 months, according to a study from PGIM Investments. PGIM is the global asset management business of U.S.-based Prudential Financial, Inc. (NYSE: PRU).
The finding forms part of PGIM Investments’ latest Gatekeeper Pulse® study, which canvassed the allocation plans, investment attitudes and manager preferences of 210 UK, continental European and Asian gatekeepers at large global financial institutions — all of which have assets under management of at least US$1 billion. The study aimed to explore the issues that matter most to billion-dollar decision-makers in fund selection.
The study found the majority of gatekeepers are slightly pessimistic about the prospects of the global economy and risk assets over the coming year, with most respondents expecting increased equity market volatility. However, opinion remains quite varied, as highlighted by the fact more than a third of fund selectors predict global growth will accelerate from here.
The study also found that fund selectors foresee much uncertainty amid unresolved economic issues, with diverging expectations for growth, inflation and monetary policy, among others. They also report a preference for actively managed solutions.
Despite ongoing uncertainty, improved fixed income fundamentals have sparked renewed interest in the asset class, with gatekeepers expecting to boost net bond allocations: 58% of gatekeepers indicated intentions to increase allocations versus 7% who indicated decreasing allocations.
While fund selectors are likely to increase exposure to almost all asset classes over the next 12 months, there was a major gap between fixed income and the next-placed area of demand, on a net basis, which was private equity at 17%. Public equity was at 14%.
Within fixed income, half of all respondents are set to boost positions in green bonds and investment-grade credit over the next year, followed by sovereign debt at 43% of respondents. The primary regional difference between the allocators was within emerging market debt, with 51% of Asian gatekeepers set to increase exposure to EMD, versus just 36% for their European peers.
Importantly, while investors have been challenged by the increasingly correlated performance of bonds and equities in recent years, more than two-thirds of gatekeepers believe fixed income will reclaim its long-held role as a portfolio diversifier to stock volatility. As for the primary reasons for the likely jump in fixed income positioning, the fund selectors cited expectations of peaking interest rates and cooling inflationary pressures.
Matt Shafer, head of international distribution at PGIM Investments, understands the heightened optimism of gatekeepers towards fixed income:
“The revival of fixed income is undeniable and demand for the asset class continues to gather pace with our investors,” Shafer says. “While interest rates have spent more than a decade at ultra-low levels, our investment team at PGIM Fixed Income expects developed market rates to experience a sustained period hovering within the traditional long-term range of 3% to 5%. Should this materialise, the team expects investment-grade returns in the mid-single digits for the foreseeable future, with high-single-digit returns for higher-risk sectors.”
Shafer adds, “With the majority of rate hikes now in the rearview mirror, we could also see reduced fixed income volatility and a reemergence of the ‘search for yield’ — which can provide an additional performance boost for bond strategies.”
Demand for global equity and improved disclosures
Within equities, the top target for increased gatekeeper allocation over the next 12 months is global equity, at 51%. Selectors are also seemingly more optimistic about previously unloved emerging market (ex. China) equity, with 44% expecting to elevate exposure to the diverse region.
Similar to the trend within fixed income, gatekeepers appear to have enhanced confidence in their local markets, with 65% of Asian fund selectors set to boost positions in Asia-Pacific equities, with only 41% of their European compatriots expected to increase weightings in the region. The roles are reversed when looking at European stocks, with 39% of European gatekeepers likely to up European equity positions, while just 24% of Asian selectors are expected to do so.
Additionally, as the transition to a low-carbon economy continues, equity strategies aligned with the carbon solutions theme are becoming more prevalent. Here, seven in 10 gatekeepers believe it is important for funds focused on global decarbonisation efforts to disclose “avoided emissions” for holdings — a disclosure that remains scarce today.
Shafer comments: “Investors clearly understand the benefits of avoiding emissions, but because this is harder to calculate, many traditional decarbonisation strategies do not account for it. But while it is certainly challenging to account for avoided emissions today, we believe it is crucial to try. If investors simply prioritise operational emissions generated by a company — such as power plant pollution or automobile exhaust — it will impede global decarbonisation goals. In addition, this narrow focus vastly underestimates the universe of investment opportunities on offer within carbon solutions.”
Finally, a net 16% of gatekeepers plan to increase commitments to liquid alternatives over the coming 12 months. Within this category, global macro, long-short equity, and multi-alternative/multi-strategy are firmly the favoured destinations of additional allocations.
Shafer concludes, “Liquid alternatives are going to remain one of the top asset allocation considerations for fund selectors. With volatility here to stay, liquid alternatives are an attractive solution to investors given they can offer uncorrelated returns and yield, boosted diversification, and low beta to traditional markets.”
