Great rotation seen muted by pension-fund demand

A shift by household investors from bonds into equities that Bank of America Corp. dubbed the great rotation is being muted as pension funds and insurers boost fixed-income assets to match future obligations.

U.S. companies with the largest defined-benefit pensions increased allocations into fixed-income to 41.3% from 36% since 2010, putting a greater share into the market than into equities, according to JPMorgan Chase & Co. analysts and data from actuarial and consulting firm Milliman. Life insurers are replacing maturing structured securities with corporate bonds, and sovereign-wealth funds with $4.3 trillion of assets are investing 90% of it into debt, the analysts said.

“If there were this rotation from individuals from bonds into stocks and it created higher yields and stronger stock performance, it would quickly find a match on the other side of the trade from the institutional pension community,” money manager Jeffrey Gundlach, whose $33.9 billion DoubleLine Total Return Bond Fund had its biggest net withdrawal in September, said in a telephone interview. “I don’t think it’s some sort of runaway condition.”

The demand from institutional buyers is mitigating $166 billion of withdrawals from bond funds earlier this year amid mounting concern the Federal Reserve was poised to start scaling back stimulus measures that have pumped more than $3 trillion into the financial system. Bank of America strategists in January called a retreat from corporate bonds by mutual-fund investors the “biggest risk” to investment-grade debt.

Aging Boomers

Yields on dollar-denominated, investment-grade debt, which fell to a record low of 2.65% on May 2, have since risen to 3.33%, according to the Bank of America Merrill U.S. Corporate Index. The higher rates have attracted institutional investors to add to their positions, JPMorgan analysts led by Joyce Chang, the New York-based global head of fixed-income research, wrote in a report last week.

Pension funds and insurance companies are matching their liabilities to prepare for the retirements of about 78 million U.S. baby boomers, or those born from 1946 to 1964, boosting demand for fixed-income assets.

“I find it difficult to believe that an aging investor population is going to be ratcheting up their holdings in riskier assets,” said Gundlach, chief executive officer of Los Angeles-based DoubleLine Capital LP.

Default Swaps

Elsewhere in credit markets, the cost of protecting corporate bonds from default in the U.S. declined, with the Markit CDX North American Investment Grade Index, which investors use to hedge against losses or to speculate on creditworthiness, decreasing 0.1 basis point to a mid-price of 73.2 basis points as of 10:34 a.m. in New York, according to prices compiled by Bloomberg.

The measure typically falls as investor confidence improves and rises as it deteriorates. Credit-default swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a contract protecting $10 million of debt.

A gauge of the health of U.S. financial conditions fell from a record high. The Bloomberg U.S. Financial Conditions Index, which combines everything from money-market rates to yields on government and corporate bonds to volatility in equities, decreased 0.03 to 1.78. The gauge ended yesterday at 1.81, the highest level in data dating back to January 1994.

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