Institutional investors have been forced to become more adventurous in their hunt for income and are investing in a more eclectic range of assets.
But despite the intensifying search for yield, data gathered by MandateWire — an FT research and analysis service — show that flows into fixed income by institutional investors in Europe and North America fell last year.
By contrast, Asian institutional investors renewed their appetite for fixed income, pouring a net £31.6bn into the asset class, reversing net outflows of £214.6bn in 2015 and £193.5bn in 2014.
The turnround in Asia is mainly explained by a change in strategy at large Japanese institutional investors such as the Japan Post Bank and the Government Pension Investment Fund. Over the past few years, they have been reducing their heavy exposures to domestic bonds and boosting allocations to equities. Investors started to wind down these moves last year.
In Europe, the significant year-on-year reduction of flows into fixed income in 2016 was the result of several institutional investors making smaller bond investments. The previous year’s data were also skewed by Allianz Group, the German insurer, whose large fixed income allocations significantly boosted flows into the asset class.
In their hunt for income-generating assets, European investors turned mainly to alternative credit in the hope of receiving higher and more diverse returns.
MandateWire tracked large net outflows in Europe from more traditional forms of debt — such as investment grade corporate bonds, which tend to be less risky, and emerging market bonds — while institutions sharply increased allocations to private debt and maintained large flows into mortgages last year.
One sign that European investors are increasingly looking to non-traditional sources of income is the spike in demand for private debt funds, which provide financing to small and medium unlisted companies. Net flows into private debt shot up to £3.6bn, from £344m in 2015.
Also in alternative fixed income, European investors targeted mortgages, which attracted net inflows of £4.2bn, only slightly down on the £4.3bn committed to mortgages in 2015.
These mortgages deliver more return than government bonds, while the risk is comparable
Much of the interest in mortgages has come from Dutch pension funds and insurance companies, stepping in to a gap in the market vacated by traditional lenders such as banks.
Late last year the Pensioenfonds Metaal en Techniek, a plan based in The Hague, increased its exposure to domestic mortgages for a total investment of €3bn (£2.6bn), or just under 5 per cent of its portfolio.
“These mortgages deliver more return than government bonds, while the risk is comparable,” says Inge van den Doel, chief investment officer for the Dutch industry-wide pension scheme for industrial companies.
But despite the increasing focus on alternative credit, European institutions pulled a hefty £2.7bn from loan investments last year, reversing net inflows of £1.1bn in 2015. This was in spite of investment consultants advising their clients to look to the potential for higher yields from loans.
In North America, the drop in net flows into fixed income is explained by investors increasing allocations to equities and alternative assets.
They pulled money out of investment-grade corporate bonds and boosted their exposure to riskier high-yield bonds and emerging market debt.
But it was alternative credit that attracted the most attention, as income-hungry investors significantly increased allocations to private debt.
The focus on higher-yielding fixed income has continued in 2017, with the appetite for private debt and high-yield bonds showing signs of increasing in North America.
Noel Collins, senior fixed income consultant at Mercer, notes that many investors in investment-grade bonds have taken profits and moved into higher-yielding assets. But he says that Dutch institutional investors are moving into investment-grade bonds in a bid to earn more yield than they are getting from their cash deposits.
Total investment in domestic mortgages by Pensioenfonds Metaal en Techniek
“Unless we get a very significant bear market shock, the investment-grade market even at relatively tight spreads is highly likely to beat the return on cash,” he says.
Mr Collins adds that institutional clients are mostly being advised to consider gaining exposure to securitised debt and private debt through multi-asset credit funds that invest in assets such as real estate debt, infrastructure debt, asset-backed and mortgage-backed securities and “higher quality” collateralised loan obligations.
He notes that institutional investors are increasing their allocations to fixed-income assets such as emerging market debt, high-yield bonds and loans as they try to build broader growth portfolios that are less reliant on the stock market.
However, Mercer has seen relatively less demand from institutional investors to lend money over the past 12 months. Mr Collins says investors view loans as a challenging sub-asset class.
“They tend to need more specialised managers for loans,” he says. “[Investment in loans] requires a higher level of analysis. The settlement requirements are also more difficult.”