Nomura: Equity-Bond Correlation Will End This Year

(September 20, 2013) – Good news for diversification: the recent relationship between the returns of bonds and equities is about to end, according to fund manager Nomura.

During periods of low yields, stock and bond prices returns should be expected to be correlated, the fund manager said.

This means that as global bond yields begin to rise, the change in environment should also be good for equities.

“With yields rising, term premiums increasing, and starting levels of risk aversion measures being elevated, historical relationships would lead us to conclude that equity-bond correlation should be negative over the next year, and that this should be equity positive,” the report said.

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The full Nomura report can be read here.

Investors who want to spot the unwinding of correlation before it starts are being advised by one strategist to look to the junk bond market.

Chad Karnes, chief market strategist at the ETF Guide, wrote that junk bonds have historically always been highly correlated with equities, which means you can use that relationship to compare high yield debt price movements with equity price movements to find warning signs, red flags, and trade setups.

“Looking at the junk bond market’s signals more recently, there were some telling signs warning of the recent short-term equity peaks,” Karnes wrote.

“During the equity markets’ May topping process, junk had already peaked and turned down two weeks earlier. Again in July, the junk debt market peaked two weeks before the equity markets. These two peaks in the junk market warned of weakness to come in the equity markets.”

Junk is currently on a downward trend at the same time as equities are returning to new highs. Karnes predicted that if junk returns move higher, it will confirm the breakout in equities, but if it stays below its July peak, it will again warn that the equity market rally will likely be short lived.

Karnes’ report can be read here.

(September 19, 2013) – The Alaska Permanent Fund—channeling its own external-CIO program, as well as the strategic partnerships pursued by Texas Teachers and New Jersey—has committed $750 million to private-equity giant Carlyle.

“We’ve had our external-CIO program in place for a couple of years now,” said Jay Willoughby, the fund’s CIO, referencing the fund’s allocations to Bridgewater Associates, Goldman Sachs Asset Management, GMO, PIMCO, and AQR that gave the firms broad mandates to invest across traditional portfolio buckets. “Now we’re trying to do the same thing in the private markets.”

The Carlyle investments will focus on energy, according to Executive Director Mike Burns. “We’ve reached out to several firms that have multiple capabilities, and we want to access their whole platform,” he said. “We want their best thinking. Carlyle is the first one we’ve done a deal with—and, as it turns out, we are focusing on the energy side. They think that’s where they have their best ideas.”

As part of the deal terms, no more than 50% of the capital can be put in traditional Carlyle Group funds. The remainder will be co-invested and/or used for “pre-fund direct” investments—attractive investments that may not be otherwise offered on a co-investment basis—according to Willoughby.

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This is not the fund’s first foray into this relationship structure—and likely won’t be its last, according to Burns. Along with the allocations to the external-CIO providers, Alaska Permanent has consolidated some emerging markets mandates into a small number of firms—including Capital Guardian, Mondrian, and PIMCO—who “can access debt, equity, and currency managers. The real experts in the equation are them, so they should be looking across investments to see where the best opportunities are.”

The progression from the public-market external-CIO program to the private market program was no coincidence. According to Burns, the fund first got comfortable with the structure before applying it to less liquid transactions. “With this private-CIO program, the challenge is that, by nature, these are longer-term relationship,” he said. “It’s like being married. In a public market deal, you can exit when you want. It’s not that way in the private markets.

“We don’t know the pace at which we’ll allocate to other managers quite yet, but we’re talking to a lot of potential partners,” Burns said.

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