Most folks don’t view the financial markets as an epic battle between equity investors (stock market) and debt investors (bond market) anymore. Memories of past skirmishes have faded over the last 10 years as the battle lines have not moved since the Great Recession.
However, long-term institutional investors remember the past and may be rekindling the battle.
Many large-scale investors approach the financial markets with a target rate of return in mind. Pension funds, endowment funds, insurance companies, and other huge institutions generally have a long-term target return for which they are striving when designing their portfolio allocations.
While seeking return, these institutions are also quite risk aware. They would like to take the least amount of investment risk necessary to achieve their target long-term target returns.
In early February the stock market experienced a correction that was at least partially caused by some long-dormant battle lines being redrawn. For the last 10 years or so the battle lines were quite clear: long-term investors could earn close to nothing by investing in cash or the bond market or invest for more growth in the riskier stock market.
Now that higher interest rates are available in the bond market, institutions are likely reevaluating whether they can reduce their allocation to the stock market and still achieve their target rate of return.
If interest rates continue to rise as expected we will likely see a return to regular skirmishes between equity investors and debt investors who are adjusting their portfolios to be risk-efficient. This would reinstate a normal and healthy part of the financial markets that has been absent for almost a decade.
At IAG our investment process is also designed to be risk-efficient. Our Investment Committee meets regularly to discuss the risks and opportunities we see in the financial markets and we will continue to make adjustments to our clients’ investment strategies to adapt to this new (yet normal) reality.
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