‘Bonds Are Back’: Allocators Eye Elevated Returns

Amid many years of low interest rates, bonds were the boring corner of allocators’ investments. No more. With rates on the rise, fixed income is getting new respect—and institutional investment dollars.

Bonds now offer “much more attractive returns,” with annual estimated performance of 4.25% over 10 years, as opposed to 1.75% projected a year ago, according to a study by consulting firm Callan. Further, 88% of institutional investors in the U.S. and Europe intend to expand their focus to include yield, meaning adding more bonds, in addition to the customary emphasis of growth, a survey from asset manager Managing Partners Group concluded.

Pension funds likely will add between 2 and 5 percentage points to their bond allocation in the near future, says Christopher Ailman, CIO of the California State Teachers’ Retirement System, which had $307 billion in assets as of March 30. While he is not committing CalSTRS to any certain allocation, he enthuses that “bonds are back.”

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Meanwhile, another Golden State pension giant, the Los Angeles County Employees Retirement Association ($72.4 billion as of March), will consider expanding its bond allocation at a policy meeting this summer. As of fiscal 2022, fixed income was about 28% of LACERA’s assets under management. Stopping short of commenting on any specific action up ahead, CIO Jonathan Grabel says that “higher interest rates influence asset allocation,” and there “may be more bonds” in the fund.

This sentiment finds echoes across the allocator spectrum. The Alaska Permanent Fund ($75.6) aims to cancel a plan to trim its bond allocation to 18% from 20%.

Bonds were long viewed as the ballast in a portfolio—not much appreciation expected, low interest rates providing little income, but key to offsetting equities’ occasional slumps. As such, bond allocations have been shrinking in pension plans for years. In 2003, they were 32.3%, and in 2020, 23%, per the Boston College Center for Retirement Research.

That formulation got trashed in 2022, when both stocks and bonds tanked. Now, with higher yields expected to stay high, the thinking has shifted: Fixed income is chiefly an income provider these days. Hence, allocators are again interested in the sector.

BlackRock, the world’s largest asset manager, stated in a new report: “We like bonds for income even if we don’t expect them to offset risk-asset slides as much as they did in the past—or gain in price from falling yields.”