Fund managers shun bonds as inflation expectations fall
A sharp drop in inflation expectations has failed to sway institutional investors away from record underweights in bonds, creating a potential entry point for contrarian buyers.
Institutional fund managers are heavily underweight bonds, with a net overweight ratio of minus 34%, according to the latest BofA Securities Global Fund Manager Survey. The survey, conducted between July 2 and July 9, indicates that the percentage of managers holding fewer bonds than their benchmarks exceeds those holding more by a wide margin.
This persistent aversion to fixed income occurs despite a dramatic shift in macroeconomic expectations that should logically support bond prices. "A net 4% of July [survey] investors expect lower global inflation, a big flip from last month when net 45% expected higher inflation," said BofA strategist Michael Hartnett and his team. "The outlook on rates fell alongside the [consumer-price index] outlook … net 1% expect higher short-term rates, down from 34%."
Expectations for Federal Reserve policy have also cooled. The survey found 83% of participants expect no rate hike before the November midterm elections, compared with just 14% who anticipate one. For next year, 36% expect at least one hike, while 29% expect none. Because bonds perform well when inflation falls—increasing the purchasing power of their future interest payments—these conditions typically draw institutional capital into the asset class.
Herd Mentality Creates Opportunity
Instead, institutional money has crowded into equities, particularly U.S. stocks, leaving bonds and cash deeply underweight. Cash allocations have dropped to an average of just 3.6% of portfolios, a level BofA Securities describes as "uber-low."
Historically, when large fund managers move as a herd and abandon an asset class, they drive prices down and create a buyer's market. This dynamic often leaves yields at attractive levels for investors willing to take the other side of the trade.
Current yields reflect this discounted pricing. The Vanguard Total World Bond ETF, which splits holdings evenly between U.S. and non-U.S. bond indices, offers an SEC yield of 4.23%. The iShares Core U.S. Aggregate Bond ETF, holding U.S. Treasuries and investment-grade corporate debt, yields 4.58%.
For investors focused on preserving purchasing power, U.S. Treasury Inflation-Protected Securities present another avenue. The Schwab U.S. TIPS ETF provides access to these government bonds. While TIPS coupon payments vary with inflation, the U.S. Treasury reports that current "real" yields range between 1.9% and 2.9% depending on bond maturity, a level considered generous by historical standards.
