• Respondents believe fixed income investing faces “new normalization” defined by modest growth, low yields, low inflation and ongoing central bank intervention
• Broad confidence in the continued strengthening of the global economy with less concern over rising inflation, although Asian investors less confident than peers in Europe, US
• Alternative credit has become an important part of fixed income universe in recent years, appetite remains strong but growing more slowly, reflecting the need to carefully select opportunities
Hong Kong, January 29, 2018: Invesco today released its first Global Fixed Income Study, an in-depth report on the investment behavior of fixed income investors. The study reveals that many investors believe the sustained post-financial crisis period of calm in fixed interest markets is coming to an end as central bank intervention begins to wind down.
The study, which analyzed responses from 79 institutional investors including 21 based in Asia Pacific with over US$1.2 trillion in assets, revealed that investors broadly believe the global economy has entered a “new normalization”, featuring modestly improved economic growth and continued low yields, along with low inflation and ongoing central bank intervention. Nonetheless, they are confident on the continued strengthening of the global economy, with most expecting central banks to increase rates and begin tapering.
“With improving market fundamentals and tightening monetary policies, the study revealed that fixed income investors in Asia Pacific tend to allocate to solutions that can either hedge interest rate risk or deliver superior capital appreciation and yield,” said Terry Pan, Chief Executive Officer Greater China, Southeast Asia and Korea at Invesco. “Recent years have also seen growing interest from investors in alternative credit such as bank loans and emerging market bonds, and we expect this asset class will continue to be popular among Asia Pacific investors for the near future.”
A majority of investors surveyed (58%) believe the global economy is on the path to recovery, but not the typical normalization which has historically occurred after an economic slump. The majority further believe a shift has occurred and improvement in key metrics is expected to be subdued with moderate rates of economic growth; gradual increases in central bank interest rates, resulting in yield curves rising at the short end faster than at the long end; and little concern over the risk of rising inflation.
Asia Pacific in focus
Fixed income investments are increasingly critical to Asia Pacific portfolios. More investors (43%) in the region increased their allocation to core fixed income over the past three years than those who decreased their allocation (38%). Furthermore, the proportion of those who increased allocation to alternative credit such as infrastructure and real estate debt stood at 52% versus only 10% that decreased their allocation. Several factors account for this increased allocation, including using alternative credit to generate alpha and improve diversification while also facing lower capital charges than other risk assets.
Still, Asia Pacific investors have lower allocations to alternative credit than their North American or European peers, however this could change as a larger proportion of Asia Pacific investors intend to increase their alternative credit assets to include new exposures such as emerging market debt, high-yield corporate debt and bank loans.
In terms of expectations for the global economy, Asia Pacific investors are significantly less positive than their peers in Europe and North America. Only 15% of respondents believe the global economy is strengthening, while 70% are neutral. Moreover, 35% of Asia Pacific respondents believe that central banks in the region will move from quantitative easing to quantitative tightening.
Investors in the region are most concerned about regulatory challenges both at present and in the future; they are less concerned about low yields or aging populations than their North American or European peers.
“Indeed, Asian investors and particularly Asian insurers face unique regulatory challengers, particularly around the C-ROSS regime which will affect the Chinese insurance market,” added Mr Pan. “Many insurers have large guaranteed books with high return requirements, and these guaranteed rates are higher than sovereign bonds yields, but regulation is meanwhile encouraging greater use of less risky debt instruments. This may explain the regional interest in alternative credit we noted from Asia Pacific survey respondents.”
Among retail investors in the region, the primary objective of fixed income in their portfolios is capital appreciation, ranking above capital protection and income generation. This contrasts with European and North American retail investors, whose primarily objective is capital protection.
Global trends
The majority of investors that participated in the survey are defining what comes next as a period of “new normalization” in fixed income investing, characterized by lower yields, low inflation and renewed central bank intervention. A significant minority have a contrary view of a deflationary storm caused by an end of cycle downturn in still fragile economies. Relatively few see an inflationary boom commonly associated with the end of an economic cycle, despite this being implicit in the policy objectives of the Trump administration.
Over the last three years, the dominant challenge facing investors has been navigating the low yield environment as yields have fallen further with each successive year. However, whilst the low yield environment is still seen as having the biggest impact, there are a new set of challenges which will impact fixed income portfolios:
• Aging populations is a major concern for pension funds, both defined benefit (DB) and defined contribution (DC). DB pension funds face the biggest fallout from aging populations, with funding deficits and asset-liability mismatches already significant and at risk of increasing further.
• For insurers, tightening regulation is the major concern, with Solvency II in Europe and Risk-Based Capital and C-Ross in Asia all aiming for greater transparency and better risk management. These will be particularly challenging for insurers with large guaranteed books which have high return requirements to ensure guarantees are met.
• Increasing geopolitical uncertainty has caught the attention of fixed income investors due to the success of populist political parties, the risk of a Eurozone break up and the unpredictability of the Trump administration. Despite geo-political events having fairly limited impact so far, 70% of investors believe that they will have an impact in the next three years, compared to 55% currently.
Core Fixed Income versus Alternative Credits
The range of sub-asset classes within fixed income has grown significantly over recent decades and now spans a broad range of diverse investments. While traditional core fixed income assets continue to play a foundational role in many fixed income portfolios, alternative credit is increasingly part of the institutional fixed income investor’s landscape. On average, the investors interviewed allocate 19% of their fixed income portfolios to alternative credit strategies.
Over the past three years investors have been reducing allocations to core fixed income portfolios and increasing allocations to alternative credit portfolios. However, the majority of investors (63%) surveyed expect to rotate back towards core fixed income over the next three years, funding this predominantly from equity portfolios. Investors still expect to allocate to alternative credit but at slower rates as appetite becomes constrained by higher prices and a reduced set of opportunities.
The area of alternative credit which remains notably in favor is emerging market debt. Respondents currently allocate 3% on average to this asset class, although 29% of respondents expect to increase this allocation over the next three years in response to improving economic fundamentals, shrinking current-account deficits and lesser direct impact of raising US interest rates.
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About Invesco Ltd.
Invesco is an independent investment management firm dedicated to delivering an investment experience that helps people get more out of life. With nearly 7,000 employees worldwide, Invesco manages US$917.5 billion of assets around the globe, serving clients in more than 120 countries (as of September 30, 2017). Invesco was established in 1935 and today operates in more than 20 countries. The firm is currently listed on the New York Stock Exchange under the symbol IVZ. For further information visit www.invesco.com.