Bonds are back

November 14, 2023 10:06
Photo: Reuters

Fixed income is once again firmly in focus for asset allocators, with a study of Asian and European gatekeepers revealing strong expected demand for the asset class over the coming 12 months.

The finding forms part of PGIM Investments’ latest Gatekeeper Pulse® study, which canvassed the allocation plans, investment attitudes and manager preferences of 210 Asian and European 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.

Bonds are back as portfolio diversifier to stock volatility

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 (EMD), with 51% of Asian gatekeepers set to increase exposure to EMD, versus just 36% for their European peers, possibly reflecting a home-region trend evident in equity allocations.

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. Nine in 10 gatekeepers cite a peak in the rate hiking cycle as the reason for increased allocations to fixed income.

We believed that bonds are back in the eyes of Asian investors. Following over a decade of ultra-low interest rates, our PGIM Fixed Income team expects developed market rates to hover within the traditional long-term range of 3%-5% for a sustained period. Should this materialize, the team expects investment grade returns in the mid-single digits for the foreseeable future, with high-single-digit returns for higher-risk sectors.

With the majority of rate hikes now in the rear-view mirror, we could also see reduced fixed income volatility and a re-emergence of the ‘search for yield’ – which can provide an additional performance boost for active bond strategies.

Demand for global equity and ESG

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 markets (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, compared to 41% of their European compatriots. 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. Cited by nearly two-thirds of respondents, ESG themes – especially targeted ESG categories such as decarbonization, continue to rank high among thematic priorities. On the other hand, artificial intelligence (AI) also attracts widespread interest, especially in Asia (60%).

Spotlight on core real estate and liquid alternatives

Turning to real estate, overall fund selectors favor ESG-focused allocations (58%). Compared to the European allocators, Asian gatekeepers are more inclined to allocate to residential (34%), retail data centers (45%), REITs (36%) as well as industrial and logistics (34%), although less likely to act until valuation conditions improve. Gatekeepers in both regions are aligned in their interest in opportunistic (39%) and value-added (38%) real estate strategies, possibly reflecting unsettled market conditions, while Asian allocators demonstrate a stronger inclination towards the core strategy (41%).

Finally, about one-third of gatekeepers plan to increase commitments to liquid alternatives over the coming 12 months. Two in five say a recessionary environment would increase their firm’s appetite for liquid alternatives. Within this category, global macro, long-short equity, and multi-alternative/multi-strategy are firmly the favored destinations of additional allocations.
Liquid alternatives have been increasingly gaining traction among Asian investors in recent years. With the attractiveness of uncorrelated returns, boosted diversification and low beta to traditional markets, liquid alternatives will no doubt remain one of the top considerations of Asian asset allocators going forward.

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Head of Asia at PGIM Investments