Institutional investors’ allocations to dollar-denominated bonds have dropped to the lowest level since 2007 as strategists at Morgan Stanley and JPMorgan Chase & Co. see a shift away from the debt that may fuel higher borrowing costs.
Holdings by investors from pensions to endowments fell to 26.2 percent of assets in the second quarter, from 30.1 percent in the corresponding period of 2012, according to the Wilshire Trust Universe Comparison Service, which tracks plans that oversee $3.46 trillion. Morgan Stanley’s $1.8 trillion wealth management unit has been advising clients to cut bond allocations to the lowest in more than five years, Chief Investment Strategist David Darst said.
Dollar-denominated corporate, mortgage and government bonds, facing the biggest losses since 1994 this year, may be headed for deeper declines as investors sour on the debt. While Federal Reserve Chairman Ben S. Bernanke attributes rising yields partly to confidence in the economic recovery, higher borrowing costs are “unwelcome,” he said in July testimony before Congress.
“Equities will outperform bonds over a seven-year timeframe because bond yields are already so low,” Darst, who oversees investment strategy at Morgan Stanley Wealth Management, said in a telephone interview. “We’ve got a slight underweight in junk bonds. We have a big underweight in corporate and government bonds.”
Berkshire Hathaway
U.S. Treasury yields reached 2.74 percent on July 5, the highest levels since August 2011, with investors seeing better opportunities in equities. Speculative-grade notes yield 6.19 percent, almost the same as the 6.14 percent earnings yield on the Standard & Poor’s 500 Index of stocks.
While yields on dollar-denominated corporate, government and mortgage debt have risen 0.8 percentage point since year-end to 2.33 percent, they’re still 1.5 percentage-points lower than the average over the past 10 years, Bank of America Merrill Lynch index data show. The debt’s 2.6 percent loss this year compares with a 20 percent gain on the S&P 500.
Billionaire Warren Buffett’s Berkshire Hathaway Inc., which owns stocks valued at more than three times its bond holdings, reported a 2 percent gain in book value in the second quarter. Buffett told investors in February 2012 that bonds were among the “most dangerous” assets.
Pension Payments
American International Group Inc., the insurer that repaid a U.S. bailout last year, said the surge in interest rates in the second quarter fueled a $9 billion reduction in its bond portfolio. That contributed to a 2.1 percent decline in book value.