Accommodative central bank policy, an ageing Europe and the exorbitant increase in debts make interest rate hikes in Europe extremely unlikely in the short term. This increases the risk of negatively-yielding bond portfolios for pension funds and insurers. Fondsnieuws, Investment Officer Luxembourg’s Dutch-language sister publication, asked three investment specialists for their views.
It is difficult to find returns in the current interest rate climate. In recent years, low interest rates have caused pension funds and insurers to increase their assets. The “search for yield” caused bond and share prices to rise. In the first half of 2021, this trend will reverse and slightly higher interest rates on treasury bills will push prices down.
NN Investment Partners
According to Ewout van Schaick, head of multi-asset at NNIP, this effect has been largely eroded by the recent decline in interest rates. The German 10-year yield is currently at about the same level as a year ago. As share prices have risen further, most Dutch pension funds and insurers will already have a higher value of their investments than at the end of December.
In the coming years, however, there will be a turnaround, according to van Schaick. “After all, part of the government bond portfolio of European institutional investors has a negative yield and there is a good chance that the interest rate will gradually rise in the coming years. Pension funds and insurers will then start to book negative yields on these bonds.”
“In this scenario, investors will, where possible, shorten the duration of their bond portfolio, but within the current pension system, the scope for most Dutch pension funds to do so is limited. Also, the scope to invest more in equities has already been largely filled by most pension funds and insurers in the Netherlands and expanding it is difficult.”
To increase the return on the bond portfolio, investors will, in that scenario, seek greater exposure to alternative and less liquid investments, Van Schaick argued. Credit and liquidity premiums offer the possibility of achieving higher returns at the same maturity. Green bonds, emerging markets debt, mortgages or trade finance are examples of investment categories in which van Schaick said he sees increasing interest.
Aegon Asset Management
Within Aegon Asset Management’s multi-asset funds, periodic (dynamic) allocation adjustments are made based on the long-term return expectations of the various asset classes, according to multi-asset portfolio manager Robert-Jan van der Mark.
“In recent years we have mainly built up an overweight in more alternative fixed-income categories compared to government bonds. For example in Dutch mortgages, which have an attractive interest rate premium compared to government bonds with a low risk profile. Many Dutch mortgages benefit from a government guarantee through the NHG (National Mortgage Guarantee), further reducing risk.”
Aegon AM also has an interest in European asset-backed securities, van der Mark said. “Asset-backed securities have a low duration, as the majority have variable interest rates. These investments, too, still carry an attractive interest rate premium. Partly because this asset class has benefited far less from the ECB’s quantitative easing (QE) programmes than government and corporate bonds.”
PGIM Fixed Income
In an interview with Fondsnieuws, Robert Tipp, head of global bonds for PGIM, said investors should stick to their strategic asset allocation in this environment. “My view is that people should accept that cash returns will be very low, bond returns are likely to be better than cash returns, and equities are likely to outperform bonds.”
“The mistake I see investors making is that they get scared when interest rates are lower than expected. Some hold cash in anticipation of rising interest rates. So instead of investing in US 10-year bonds at 1.3 per cent or a 10-year Bund at minus 30 basis points, European investors are sitting on cash at minus 50 basis points. They think the market will continue to fall in value, but my assessment is that markets will be stable and we will see bond yields rise.”
“Investors will want to “fight” the expectation that interest rates will remain low for a long time. Many will lose money by investing in short-term bonds, for example. The most interesting strategy for me as a portfolio manager is the hedged global fixed income strategy. If you have to trade in an environment where most bond markets will have low interest rates and fluctuating narrow ranges over the next few years, it is smart as a manager to track all interest rates from all markets. Fluctuations between markets and exchange rates is something where you can still get returns as a bond investor in this interest rate environment.”