Credit investors squeezed by the tightest spreads in almost 20 years are opting for bare-bones strategies, creating a boom for Europe’s fixed-maturity funds.
These previously-niche funds invest mostly in investment-grade corporate bonds, offering investors a fixed annual yield and the return of their money at a set date. This straightforward pitch has become irresistible at a time when other sources of income, including risk premiums over government debt and more complicated bets on subordinated or higher-risk corporate bonds, are vanishing.
Fixed-maturity funds in Europe with at least 50% allocation to corporate bonds now command close to €113 billion ($119 billion) of assets, based on data compiled by Morningstar Direct. That’s almost triple the amount they oversaw two years ago, with growth coming as the likes of BlackRock Inc. and M&G Plc pile in. They’re particularly popular with retail investors, though institutional money is also involved.
“Over the last 18 months we have seen a massive rise in fixed maturity,” said Neal Brooks, global head of distribution and product at M&G Investments. “Interest rate policy has been slower than many predicted. Given a perception of higher-for-longer rates, spreads may be narrow but the yield is still attractive,” he said.
M&G’s assets under management in fixed-maturity funds are set to approach €2 billion by the end of the year, up from zero before 2023.
The funds are typically built during a ramp-up period of a few weeks, during which the manager packages a bundle of bonds with a similar maturity to the fund and investors subscribe to it. They’re sold via private banks and insurance companies and are designed to return the money invested once the last bonds mature.
“It’s the yield and the simplicity of them that is attractive to clients,” said Simon Blundell, head of European fundamental fixed-income investments at BlackRock. “Whatever number you see will only be a part-representation as to the amount of money that been invested in this way over recent years.”
Fixed-maturity funds started to become more popular a couple of years ago, when central bank interest-rate hikes caused a jump in bond yields. While that dynamic may be reversed at some point, with banks including the Federal Reserve and the European Central Bank now cutting rates, the funds’ assets keep setting records.
That’s because of pent-up demand for fixed maturity as investors waited for evidence that yields have peaked, according to BlackRock’s Blundell.
And for investors, “it’s all relative,” according to Goldman Sachs credit analysts, who highlighted in a presentation last week that yields are historically high while spreads are historically tight.
The average yield on Bloomberg’s global investment-grade corporate index is 150 basis points above its 10-year average, even after coming down from late 2023 highs. At the same time, relentless inflows into fixed-income assets and improved credit fundamentals have left spreads on the index near the lowest since 2007.
“Fixed maturity funds have constituted a new investable sub-structure in the investment-grade universe that has been particularly successful in attracting retail money with the promise of juicy low-risk yields,” Deutsche Bank strategists including Steve Caprio wrote in a recent report.
To be sure, investors in fixed-maturity funds risk missing out on big price rallies due to their bonds returning to face value by the time the fund matures. And there’s the added risk of yields in the market being much lower by the time they need to reinvest their money.
Still, with little extra reward expected for more complicated trades, these simple yield-based strategies are likely to remain popular.
“We think that investors will be incentivized to lock in the still relatively high yields on offer,” Bank of America credit strategists Ioannis Angelakis and Barnaby Martin wrote in a report.
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