The world's most powerful central bankers may be worried about lofty stock market prices. But Goldman Sachs Asset Management's Sheila Patel says the world's largest investors are just as stressed out about being stuck on the sidelines as they are falling victim to a sharp correction.
On Tuesday night Federal Reserve chair Janet Yellen's description of asset prices as "somewhat rich" based on traditional measures such as price to earnings ratios contributed to a weak trading session as traders contemplated the risk of a correction.
"Clearly from what Yellen just said to the broader constituency of investors that we work with, there is some concern [about high equity market valuations]," said Ms Patel, who is the chief executive of the international operations of fund manager Goldman Sachs Asset Management.
"But the broader group of investors have been underweight [equities] so the concern is counterbalanced by that fact."
"You can absorb quite a bit of volatility in equity markets if you are already significantly underweight relative to where you think you should be."
Ms Patel, a leading global asset manager who is based in Singapore, said investor clients were encouraged by improved economic data and while valuations were high there were "still not anywhere near the peak valuations that have led to big corrections in the past".
Risk appetite
A trio of Fed commentary about lofty financial asset prices was led by Ms Yellen but followed up by Fed vice-chair Stanley Fischer and San Francisco Fed president John Williams.
It sparked renewed debate about the sustainability of the equity market rally that has seen the US S&P; 500 index gain 8 per cent this year while the technology heavy NASDAQ index is up 14 per cent.
Mr Williams said the market "seemed to be running very much on fumes" while Mr Fischer noted an "uptick" in risk appetite that had pushed up asset prices.
But many investors, Ms Patel said, "are probably more concerned with missing [the rally] because of their low overall allocation".
While Ms Yellen said she couldn't comment on what were appropriate valuations they "ought to depend on long term interest rates".
At present, those long-term bond rates are stubbornly low with the US 10-year Treasury rate yielding just 2.2 per cent, even after a sharp seven basis point spike on Tuesday.
The benchmark rate has slid from 2.6 per cent in March despite two rate hikes this year and signals from Fed officials to expect more increases as it begins trimming its $US4.5 trillion balance sheet.
It's these persistently low bond rates that are causing the biggest headaches for large insurers and pension funds that have to finance future benefits, Ms Patel explained.
"It's been a real challenge for many of the large institutions that generally have very large long-dated liabilities and not many long-dated return opportunities to match these off."
Powerful influences
She said uncertainty about the policy direction of central banks other than the Federal Reserve was partly responsible for holding down long-term bond rates.
"When you look at an uncertain world there is still a fair bit of demand and confidence in US Treasuries and in US fixed income markets. That by nature will keep rates low."
But she said there were other more powerful influences on the bond market beyond central bank decisions that had worked for keep interest rates low.
"You have an ageing population that de facto tends to lead to more investments being in fixed income."
She said older savers were unlikely to shift money out of bonds and into stocks no matter the return prospects "because fixed income is the natural match in terms of that risk-reward profile".
"Look at the world population versus world wealth and the math on fixed income makes more sense."
