Talking Heads – Le nouvel attrait des obligations dans les allocations d’actifs à long terme

This is an audio transcript of the Talking Heads podcast episode: The newly found appeal of bonds in longer-term asset allocations

Daniel Morris: Hello and welcome to the BNP Paribas Asset Management Talking Heads podcast. Every week, Talking Heads will bring you in-depth insights and analysis through the lens of sustainability on the topics that really matter to investors. In this episode, we’ll be discussing long-term asset allocation. I’m Daniel Morris, Chief Market Strategist, and I’m joined today by Sergey Pergamentsev, who manages our long-term multi-asset portfolios. Welcome, Sergey, and thanks for joining me.

Sergey Pergamentsev: Hello, Daniel. Thanks for having me.

DM: For our long-term multi-asset portfolios, our clients are primarily pension funds and insurance companies considering how to allocate their portfolios for returns over the next five to seven years. When you think about traditional multi-asset allocation, what are the some of the challenges that you face in the current environment?

SP: We are coming from an environment of deflation and ultra-low interest rates in most major economies to a high inflation environment. Over the last couple of years, fixed-income investors lost money. We now seem to be in a position where central banks are starting to believe that they can get inflation under control. Whether they can reach the [core inflation] target of around 2% over the long term remains to be seen.

What does that mean in practice? Some time ago, we saw what was, in my view, the prematurely declared death of 60:40 multi-asset portfolios [60% equities, 40% fixed income]. Now you see more and more people starting to be more bullish on fixed income, which makes sense, especially for longer-term investors.

Fixed income has had decent returns recently, but also quite decent return expectation. Most of the longer-term models suggest that yields will continue to fall gradually. That should bring us to the environment we have been familiar with over the last 10 or 15 years, which is not to say that we’ll again see zero or negative rates.

What’s important at the moment are the expectations on inflation and interest rates and how those impact equity movements. Interestingly, the correlations between equities and fixed income have not been stable lately – they flip from positive to negative and back, so it is not a trivial task to decide how one should position portfolios.

The overwhelming theme is that there is a good premium to be earned in multiple asset classes and having different assets in your strategic portfolio makes sense.

DM: In your view, the 60:40 portfolio is at least a relevant starting point, but we’re all aware that’s not as far as it needs to go – you probably need to have more than just public bonds and public equities in a portfolio. What are some of the recent trends in multi-asset investing, in particular around the inclusion of other types of assets in portfolios?

SP: Over the last couple of years, there has been a clear trend towards including illiquid assets in multi-asset portfolios. These assets have two functions: One, they provide you with an illiquidity premium, which is a nice, stabilising part of the return, and, two, by their nature, they are less volatile than listed assets.

Obviously, that [premium] doesn’t come for free and one needs to be cautious about managing liquidity and understanding how the interaction between liquid and illiquid assets in the portfolio can develop under different scenarios and market developments. Even so, the introduction of more and more illiquid assets in various forms makes quite a lot of sense.

We are also seeing regulations developing in this direction. For instance, in Europe, there is a new fund regulation, the so-called ELTIF 2.0, expected to come into force in the first quarter of 2024. This will allow for the structuring of less liquid funds with some secondary liquidity function around them. This can appeal to more affluent investors, but also allows retail investors to start participating in less liquid funds.

Beyond those, it allows multi-asset funds and clients to be able to place not only subscriptions, but also redemptions of the fund to facilitate a rebalancing of their portfolio. That helps us to move forward with illiquid investments and incorporate them into multi-asset portfolios.

Lastly on this subject, we are seeing more and more of a sustainability angle introduced into the portfolios in the form of thematic funds, and more generally, the implementation of an ESG framework around the investment [to help meet] the goals of the client.

DM: The assets that you’re including in your portfolios have evolved over time. Thinking about clients, how is multi-asset investing being used? Are there any trends?

SP: There are various protection strategies to reduce volatility or the downside of multi asset investments. What we see when applying this technique in practice is that even some of the reserve management clients such as corporate treasuries invest in money market products. At current rates, money market products offer quite attractive returns. So, one would think that’s actually good.

But we still see that if at least part of this money is invested in multi-asset portfolios with a protection mechanism, it can allow you to generate superior returns. Even with an inverted yield curve and high short-term rates,  [they can] substantially outperform money market benchmarks.

Another trend is with our pension fund clients, where hedging liabilities is an important part of portfolio and risk management. Traditionally, their liability-matching portfolios used to be structured using, say, government securities, maybe cash and swaps, in some cases investment-grade credit.

But now we see that the inclusion of assets such as private credit or mortgages on the one hand can provide superior returns for the portfolio. And on the other hand, it also provides additional cash flows that are needed for substantial derivative positions in swaps.

So, what on the face of it might look like a more complex portfolio in practice makes the portfolio more robust, both in terms of risk and of return. That is definitely beneficial in the current situation, when institutional investors face a still quite unclear path in terms of inflation developments.

DM: Sergei, thank you very much for joining me.

SP: Thank you, Daniel.