We are in the midst of a global shift in demographics as the Baby Boom generation ages and faces retirement, causing a need for reduced volatility in their investments. We believe this creates real issues for future money flows. We have seen it reported that approximately 75% of global equity markets are owned by pension plans and retail investors, both of which are likely to dramatically reduce stock exposure going forward.
Of this, pensions (which we have seen reported account for about 45% of global equities alone) are expected to increasingly focus on portfolio immunization, whereby they look to match the maturity of their assets and liabilities, which forces these plans to turn to credit versus equity.
On the retail side, as we have previously discussed in our piece “Of Elephant and Rates,” which was written two years ago, at the time, estimates were that nearly 75% of global retail assets would be owned either by those retired or near retirement within five years.1 This is a huge number, and as people in this demographic enter or near the retirement phase, they tend to focus on capital preservation and income generation, which we expect will cause investors to rotate out of equities into credit.
We believe that demographics are destiny. As the population ages, they will no longer be focused on taking on risk to generate higher returns via equity markets, but rather turning to the income and lower volatility provided by fixed income. While we expect this to prevent interest rates from significantly increasing as the demand for fixed income increases in the years and decades to come, we also expect it will result in less demand (or outright liquidations) and lower valuations for equities.
So while we believe that there will be little to drive further equity market valuation and price expansion over the next year and beyond (see our piece “US Financial Markets: Fundamentals and the Outlook for Equities”), we do believe the high yield market can be part of the solution for investors focusing on income.
The high yield market offers a yield to worst of 8.4% and a yield to maturity of 8.6%, far surpassing the yields offered by various other fixed income options. Additionally, high yield bonds have a lower duration, indicating less sensitivity to interest rate moves.2
While the high yield offered by these corporate bonds is commensurate with the higher perceived risk, if you look at actual performance, high yield bonds have also outperformed the other listed fixed income categories over the last quarter century. High yield has posted a 25-year return of 8.3% versus the sub-7% return for corporate investment grade and municipal bonds and negative returns for the 5-year Treasury.3
Over the long term we think it is likely that equity valuations will begin to compress and stocks will begin to lose their long term appeal as both baby boomers and institutional investors continue to pursue yield and capital preservation strategies. We believe that income focused investors should consider an allocation to high yield bonds, with its relatively high income generation, as an equity alternative to complement their fixed income allocation. To read more about our thoughts on the demographic changes ahead, our outlook for equities, and alternatively the opportunity we see in the high yield market, see our piece, “Zero Sum Game.”
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