Fixed Income can be considered as the tortoise of the investment world, with a limited price volatility and a regular return stream. Nothing to write home about. However, this asset class is one of the most important. Pension funds depend on these instruments to cover their pensioner outlays. Life insurance wrappers depend on them for their annuity distributions for example. There is therefore a massive structural demand from a part of the investment community for income generating Fixed income investments. Generally, these are large ‘investment whales’ such as those just mentioned.
As interest rates collapsed to historically low levels from 2008 to 2021, yield returns had to be obtained somehow, leading to an overweighting allocation to the asset class by these same investors. During the Fed. Fund cycle of 2022/2024 which started from a low interest rate base, the bond asset class reacted badly to these policy increases. The ‘Move Index’, indicator of bond volatility, increased close to +50% during this period from its prior 12year average. Our tortoise has become uncontrollable and looked more like an investment hare. With low returns, its mark to market pricing was erratic and its valuations down significantly.
Understandably, the investment ‘whales’ could not continue to add more fixed income instruments to their portfolios under these market conditions. With now increased yield returns in 2023, the price volatility had become so intense it was a toxic proposition to look at. As a result, many of these institutions sidelined themselves on investing in Fixed Income, waiting for the time for calmer market conditions and improved visibility.
This allocation choice is now no longer sustainable. The distribution liabilities for these large investors continue. Sitting on their hands in money market instruments pending more stable conditions mechanically increases their asset/liability miss match, exposing them to a rising reinvestment risk.
Looking forward, if one assumes a stable interest rate environment which by extension reduces the Fixed Income volatility paradigm, allocations from these large investors should progressively seep back into their traditional investment ‘sandpit’. Furthermore, if one imagines the competitive return advantage from money market allocations being eroded by a monetary policy reversal, then the pressure will be on for these same investors to come back to more classic fixed income assets with a vengeance.
Our tortoise may have been flat on its back in 2022 and 2023. ‘Shaken but not stirred’, it is recuperating its wits about it. In 2024, it is starting to move forward again, slowly at first, before gathering speed. Watch out for renewed investment flows into bonds from the large investor pools mentioned above. The strong performance at the end of 2023 showed there is still life left in the Fixed Income beast.
