In Tom Wolfe's iconic 1987 novel Bonfire of the
Vanities, Master of the Universe Sherman McCoy isn't a
stock picker; he's a very wealthy bond trader. Like McCoy,
asset managers that have focused on fixed-income investing have
gotten very rich over the last three decades as interest rates
have steadily fallen.
But things are about to get a lot harder for these asset
managers. After an unprecedented five years of loose monetary
policy in the U.S. and around the world that has pushed
interest rates to historic lows, the returns investors can
expect from fixed-income investments have changed dramatically.
In May and June, investors got a taste of the damage that
rising rates can do to bonds, whose prices fall as rates rise.
In May, when Federal Reserve Board Chairman Ben Bernanke first
hinted that the Fed could reduce its bond-buying program as
early as this fall, prices of bonds tumbled; they fell again in
June when Bernanke reiterated those comments rather than
walking them back, as many in the market had been expecting.
According to Cambridge, Massachusettsbased EPFR Global,
which tracks individual and institutional fund flows, investors
yanked $57.8 billion from global bond funds in the four weeks
ending June 28. The largest mutual fund, Pacific Investment
Management Co.'s Pimco Total Return fund, managed by Bill
Gross, had $9.9 billion in outflows in June, after posting a
negative return of 2.65 percent for the month.
The asset management industry has made a killing overseeing
bond funds because of both a rise in the value of these assets
as well as the scale efficiencies in managing bonds. In 2012,
according to the Washington, D.C.based Investment Company
Institute, a trade group for mutual funds, investors put $304
billion into U.S. bond funds, up from $125 billion the year
before. In 2009, bond funds saw a record $380 billion in net
inflows. Global revenue from 2000 to 2012 for fixed-income
managers grew 109 percent versus equity managers' growth of 73
percent in the same period. Among the top 10 firms on the
II300, Institutional Investor's annual ranking of the
300 largest U.S. money managers, are such fixed-income
behemoths as BlackRock, Pimco and Prudential Financial.
Now all fixed-income managers need to change their
investment process, and that won't be easy, according to a new
report from Casey Quirk & Associates, a Darien,
Connecticutbased consultant for investment managers.
Yariv Itah, a partner at Casey Quirk, says he expected that
when rates rose, investors would dump their fixed-income
investments. But his research showed something different
happening. Even before rates started rising in May, investors
were starting to move away from core investments into different
types of bond strategies. "Among retail and institutional
investors, there's not much appetite to decrease their overall
allocation to fixed income. But there is a huge shift into
other types of debt investments than they are in now," says
Itah. Casey Quirk expects that as investors face uncertain bond
markets they will shift $1 trillion of assets about 15
percent of their portfolios away from traditional
fixed-income areas such as core, core plus, government bond and
benchmark-oriented strategies tied to popular indices. Those
funds will be directed toward what Itah calls next-generation
debt investments, including global bonds, emerging market
bonds, high-yield and bank loan investments, structured
products and portfolios managed to protect investors' principal
against the ravages of inflation.