Asset Management: a short history of the bond market

One bit of programming to start: school’s out for summer. Don’t miss our selection of summer books — from politics, economics and history to art, food and, of course, fiction. This newsletter will be back for the autumn term on September 4. Until then . . . happy holidays.

How bonds ate the entire financial system

Bonds have long been considered the most boring bit of finance. They occasionally crop up in literature, almost always as a signifier of dreariness, writes my colleague Robin Wigglesworth in this fascinating cover story for FT Weekend Magazine.

The Great Gatsby’s narrator Nick Carraway was a bond salesman and Sherman McCoy in Tom Wolfe’s The Bonfire of the Vanities traded them. Bonds have never figured in the popular imagination in the same way as stocks, say, or corporate M&A. There has never been a “meme bond”. Ian Fleming chose the name Bond for his spy because he thought it was “the dullest name I’ve ever heard”.

Even so, they have played an integral role in the development of human society, from subsistence farming to the modern era, funding everything from wars and railways to Tesla’s electric cars and Netflix. “The bond market is the most important market in the world,” says Ray Dalio, the founder of the world’s largest hedge fund, Bridgewater. “It is the backbone of all other markets.”

While the bond market has become larger and more powerful, the importance of banks — historically the workhorses of the capitalist system — is subtly fading. The global bond market was worth about $141tn at the end of 2022. That is, for now, smaller than the $183tn that the Financial Stability Board estimates that banks hold globally, but much of the latter is actually invested in bonds — a fact that some US banks have recently rued.

Three decades ago, James Carville, the American political adviser, quipped about wanting to be resurrected as the bond market because “you can intimidate everyone”. Since then, the market has grown fivefold. Tighter regulations on traditional lenders resulting from the recent rash of bank failures in the US will force even more borrowers towards bonds.

The market is now facing one of its biggest tests in generations. Last year, resurgent inflation — the nemesis of financial securities that pay fixed interest rates — triggered the worst setback in at least a century. Overall losses were almost $10tn, shaking UK pension plans and regional banks in the US. And although bonds have regained their footing this year, they are still beset by rising interest rates.

Even if the bond market adapts, as it has in the past, its ballooning power, reach and complexity has some awkward implications for the global economy. “This transformation has been extraordinary and positive,” says Larry Fink, head of BlackRock, the world’s biggest investment group. “But we have a regulatory system designed for a time when banks were the dominant players. They aren’t any more.”

To properly understand the role of the bond market today, you have to go back almost a thousand years to 12th-century Italy. Read the full story here.

Top stock pickers hit by ‘tremendous’ amount of uninvested cash

Top active fund managers say they are struggling to attract money from large investors who are holding back in the face of volatile markets and cash accounts offering the best yields in years, writes Madison Darbyshire in New York.

Institutional investors such as pension funds, endowments and foundations control billions in capital and are responsible for the majority of allocations to the biggest asset managers. Cash sitting in US institutional money market accounts now totals almost $3.5tn, according to the Investment Company Institute, a sum that has climbed steadily this year even though stock markets are gathering strength.

“There’s a tremendous amount of money on the sidelines,” Rob Sharps, chief executive of the $1.4tn manager T Rowe Price, said in an interview. The US-based asset manager was battered over the past quarter by $20bn in net outflows and said it did not expect flows to turn positive again until 2025.

His comments come after the Federal Reserve has aggressively raised US interest rates to tame inflation, in turn boosting the appeal of cash accounts. Yields at the largest money market funds now average more than 5 per cent and are rising fast, according to Crane Data.

“You’re getting yields on money market funds that you haven’t had in 15 years,” Sharps said. “There are a lot of people who are calling for a meaningful slowdown or a recession in the economy, which creates bumpier conditions for credit and equities.”

We’re probably experiencing the worst of it right now,” he added. “Investors are waiting for the Fed to get out of the way.”

Institutional investors pulled more than $3bn in the latest quarter from active funds at AllianceBernstein, the $646bn manager. Seth Bernstein, chief executive, said “people are sitting out” after the Fed propped up short-term interest rates and may raise them further. “You’re being paid to wait,” he said.

Read the full story here.

Chart of the week

Investors are warming to the riskiest US corporate debt as optimism about the state of the world’s biggest economy narrows the gulf between the top and bottom rungs of the $1.35tn junk bond market, writes Harriet Clarfelt in New York.

The gap between the yield on double-B and triple-C bonds narrowed to its tightest level in 15 months at 6.53 percentage points in recent days, before widening slightly to 6.74 percentage points at Friday’s close — underscoring investors’ growing confidence that the US can avoid a recession even though the Federal Reserve has raised interest rates 11 times since March last year.

Such hopes of a “soft landing” follow a flurry of positive data, with persistent evidence of easing inflation and better than expected second-quarter US growth figures.

Five unmissable stories this week

Investors are increasing their bets that Europe will sink into a painful economic downturn, in a growing contrast to the conviction in financial markets that the US is headed for a “soft landing”.

Carlyle Group’s profits fell in the past quarter as the buyout group failed to benefit from a rebound in markets and struggled to drum up interest in a new flagship fund, underlining the challenge facing new chief executive Harvey Schwartz. Meanwhile, Marc Rowan, chief executive of Apollo Global Management, warned that a lucrative age for private equity buyouts has ended. 

The US House of Representatives China committee has accused BlackRock and MSCI of profiting from investments that help the Chinese military and undermine American values and security. It said the groups’ decisions meant that American investors in their funds were “unwittingly funding” Chinese companies that develop weapons for the People’s Liberation Army.

Carl Icahn’s embattled investment conglomerate Icahn Enterprises has slashed its quarterly dividend by half in an attempt to conserve cash after a short seller criticised the payouts as unsustainable.

Shares in the world’s largest listed hedge fund manager Man Group tumbled on Tuesday as performance fees and profits collapsed. Chief financial officer Antoine Forterre said the group wanted to expand further in credit and was considering more acquisitions. 

And finally

To mark the 300th birthday of artist Joshua Reynolds, a free exhibition at Kenwood on the edge of Hampstead Heath showcases the chronicler of Georgian England. And don’t miss the FTWeekend Festival at Kenwood on September 2.

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Future of Asset Management North America

Hosted by the Financial Times, in collaboration with Ignites and FundFire, Future of Asset Management North America is taking place on September 27-28 at etc.venues, 360 Madison Avenue, New York. It will bring together senior leaders from leading US asset managers, including Capital Group, BlackRock and Goldman Sachs and many more. For a limited time, save up to 20 per cent off on your in-person or digital pass. Register here