Pension funds need to become "more inventive", says Princeton's Malkiel
GLOBAL - Pension funds and other institutional bond investors will have to become “more inventive” to weather the current debt crisis, says Burton Malkiel, author of ‘Random Walk Down Wall Street’, pioneer of indexing and Professor of Economics at Princeton University.
Speaking with IPE’s sister publication IPNederland during a recent seminar by Vanguard in Amsterdam, Malkiel said he was concerned about the state of fixed income investments.
“I am increasingly worried about bond investing, because I believe we are going to be living in an era of ‘financial repression’, when governments interfere in the markets to get rid of their debt.
“I don’t think it is going to be politically feasible to tighten our belts to do it, so governments will likely attempt to solve the over-indebtedness problem in the United States, Japan and Europe by deliberately keeping interest rates near zero and under the rate of inflation, so they are getting rid of their debt on the backs of bond holders.”
The flight to supposedly safe sovereigns such as German bunds did not appear to be a very wise, Malkiel said. “That way you’re likely to earn a negative real rate of return. I wouldn’t flock to German Bunds and I wouldn’t flock to US Treasuries.
“What I would do is hold my debt in countries with a young population, a high interest rate, low debt to GDP and with lots of natural resources. And I don’t mean just oil but also arable land and especially water,” he said, noting that water would become an “increasingly important” issue in the future.
Malkiel suggested favoring sovereign debt from emerging markets with “good demographics, strong growth prospects and where you’re paid handsomely for the risk”, citing Brazil as one such example.
“Brazil boasts the largest oil field discovery in the Americas; the country is rich in metals and has lots of arable land and water. But another attractive country is Australia, which isn’t an emerging market. Chinese bond exchange-traded funds are attractive as well, even though the interest rate isn’t particularly high.”
Malkiel pioneered index investing in the 1970s and is best known as an outspoken supporter of passive management. He said investors now needed to be “modest” about both their knowledge and any lack of knowledge they may have.
He said he was “absolutely sure” about one issue, saying that the lower fee paid to a manager, the higher returns are left for investors.
“Again and again the numbers show that at least two-thirds of active managers are beaten by the index, and what’s more, the managers that do outperform the benchmark in any given period are not the same ones that outperform the index in the next period.
“Even in the inefficient emerging markets it’s very hard to beat the index,” the academic noted.
Malkiel, nearly 40 years after the publication of ‘A Random Walk’ and the eponymous hypothesis, remains a supporter of indexing - at least for the large core of the portfolio.
“In an era of financial repression bond holders are at a disadvantage, so we really have to be more inventive about what we do with our bond portfolios,” he said.
“On one hand [this is possible] by overweighting bonds in countries like Brazil and Australia, where investors are paid handsomely for the risk they take, and on the other hand by holding a satellite portfolio of high dividend paying common stocks as a bond substitute.”
Asked for an example of such a high-yield, he cited a portfolio of “utility and telecom companies with a 5%-plus yield and the possibility of growth in that dividend if we do inflate our way out of debt”.
“I realise this is an active strategy I’m recommending. But then, I never said everything has to be indexed,” he said.