Low Rates Tied to Demographics

Terry Flanagan

An aging work force and increased longevity are working to keep real interest rates low, according to Russ Koesterich, global chief investment strategist at BlackRock.

“There’s a fair amount of academic evidence that as the average age rises, generally those populations are associated with a lower equilibrium for real interest rates,” Koesterich said at a press briefing on Wednesday. “This is part of what’s been happening right now in the United States.”

Bond yields have sunk to record lows as those who have entered or are approaching retirement snap up long-dated securities, pushing up prices. “We actually have a dearth of long-dated bonds,” said Koesterich. “This is a function of the multi-year deleveraging we’ve seen in many segments of the global economy and a very significant appetite by many institutional investors to bring down their liabilities. We have an environment where supply is not keeping pace with demand and that has helped to keep prices high and yields low.”

In this low rate environment, investors have moved further out on the risk curve. “For most investors, the traditional sources of income, whether they’re bonds or cash or dividend paying stocks, simply aren’t producing the same level of return as you would have received 10 or 20 or 30 years ago,” Koesterich said.

The low rate environment is at least partly a function of demographic changes. Generally older people borrow less. A lot of the borrowing they do, whether it’s student loans, a car loan or a mortgage, happens when they’re young. As they approach retirement, older people have a preference for income and that leads in many cases to a preference for bonds.

This quest for income and the fact that it’s hard to find is somewhat of a circular problem. The combination of low nominal growth, a dearth of long-dated bonds and demographic factors “are forces that are likely to be with us for the next several years,” Koesterich said. “We’re going to be an environment of low rates for some time.”

This is creating a challenge for investors. “What normally worked for retirement when people were not living as long, when rates were higher, when people were not responsible for managing their own retirement, doesn’t work in an environment of longer retirements, self-funded retirements and lower rates,” Koesterich said.

Koesterich recommends that portfolio construction incorporate a broader range of asset classes and thinking about how to actually combine those in a way that generates a given level of return while minimizing risk.

“Investors are going to have to look at a broader array of assets,” he said. “They have to consider asset classes outside of bonds as a way to generate income, and have to think about different strategies that rely on accumulation, not just income, and have to cast a wider net.”

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