Fixed Income Panel (October 2007) - Get in touch

Sajiv Vaid
Credit fund manager
Royal London Asset Management
Vaid is a credit fund manager in RLAM’s fixed interest team and has 14 years’ experience working in global government and credit markets. He joined RLAM in 2001 and is responsible for managing a range of corporate bond portfolios for institutional and retail clients. Vaid graduated from the University of Hull in 1991 in economic and social history and holds an MA in modern international studies from the University of Leeds.

Stephen Hobbis
Client portfolio manager
Aberdeen Asset Management
Hobbis is a member of Aberdeen’s UK fixed income team that runs nearly £13bn of assets on behalf of UK institutions. He joined Aberdeen via the acquisition of Deutsche’s fixed income businesses in 2005.

Scott Mather
Managing director and head of portfolio management, Europe
PIMCO
Mather is a managing director, member of PIMCO’s executive committee and investment committee and head of portfolio management Europe. He also manages euro and pan-European portfolios. Mather joined the firm in 1998 from Goldman Sachs in New York.


Should pension schemes be contacting their fixed income managers to ensure their portfolios do not have any exposure to US sub-prime asset-backed securities?

Vaid: In present market conditions fixed income managers should be contacting clients to explain what is happening in markets. There is a lot of confusion about the US sub-prime market and clients need reassurance about the type of assets to which they have exposure; managers need to be proactive. This applies to all assets which may be giving rise to concern.

Hobbis: Yes, pension funds should contact their fund managers to check their exposure to sub-prime asset-backed securities. Exposure to risk, however, is not limited to direct holdings of sub-prime mortgage-backed securities and pension funds should seek information on their exposure to the broader impact of the liquidity crisis as well. These effects are clearly not restricted to fixed income portfolios, but can also be seen in equity portfolios and hedge funds. Pension funds should, therefore, be making enquiries of all of their fund managers.

Mather: All pension funds and/or their advisers should actively engage with their investment managers on a regular basis, not just as a consequence of the sub-prime issue. Regular audits to determine the nature and scope of the instruments in the portfolio may well have important side benefits.
For example, an audit may reveal traditional valuations and other ancillary reporting do not capture the risk factors of these instruments appropriately or that additional training of the lay trustee group is required.


Is the current liquidity crunch in financial markets likely to have any detrimental effect on pension fund fixed income investments?

Vaid: There are many ways of looking at this question. On one level there will be an obvious detrimental impact if the credit crunch leads to permanent diminution of value (i.e. defaults/bond restructuring).
In the medium term the credit crunch is likely to lead to tougher lending criteria, slower economic growth and ultimately higher defaults (this is almost inevitable from the current low levels). The key question is how high the default rate will go and to what extent investors are already compensated. Our view is investment grade bonds look attractive but high yield looks vulnerable. Clearly, government bonds have been a beneficiary of recent events although it would be fair to say present yield levels anticipate some of the slowdown we expect.
From a different perspective, the crunch and the shift in relative valuation between bonds and equities may present a good opportunity for funds overexposed to equity risk to switch into investment grade credit assets.

Hobbis: The liquidity crisis reflects uncertainty over the exposure of some financial institutions to problems in sub-prime debt. For those funds that have exposure, the impact on their investments should become clear. The side-effect has been the difficult trading conditions in the secondary credit market, where the cost of dealing has been a multiple of that experienced under more normal market conditions and, in some cases, dealing in size has been extremely difficult.

Mather: The answer to that question depends on the time scales involved. The long-term answer is no. This period of uncertainty will undoubtedly pass and the prospects for fixed income returns are quite good. However, over the short-term, schemes with interest rate swap programmes may be affected.
Schemes that have contracted to receive long-term fixed rate and pay short-term floating rate for liability-matching reasons will find the cost of financing the floating element is now much higher than expected. Until LIBOR rates fall, liability-matching will be more expensive than schemes might have anticipated.


Do investors need to be much more discrim-inatory when it comes to selecting fixed income assets today compared to six months ago?

Vaid: Credit bonds are riskier (but cheaper) than six months ago. This is because the economic and financial outlook has become more unclear. I believe there are several ways in which investors will become more discriminatory: (1) investors are likely to place less reliance on credit ratings; (2) there will be more emphasis on transparency – i.e. investors will need to better understand complicated instruments; (3) there will be greater emphasis on bond covenants and recovery rates.

Hobbis: Investors should always be careful when selecting assets. In recent years we have been operating in a very benign environment where investors have been rewarded for taking risk. The events of this summer have served as a reminder that there is a downside to taking any investment and there is no substitute for diligent research to understand the nature of extent these risks.
There are sensible strategies that investors may follow for improving the efficiency of portfolios and increasing returns per unit of risk, known as the information ratio. These strategies often involve taking some additional risks in individual investments, but combining uncorrelated strategies to diversify risk at a total portfolio level.

Mather: Investors should always be discriminating when it comes to the assets in their portfolio. The events of the past three to six months will almost certainly lead to greater scrutiny as developments have reminded everyone that riskier assets provide higher yields precisely because they entail more risk.
Low interest rates and low prospective bond returns prompted many investors, desperate for yield, to seek “steak on a plate with no wait”. By focusing on yield and ignoring risk, some investors were left with “pie in the sky with a sigh” instead.
The cathartic nature of crises like the credit crunch tends to reveal poor risk controls. A return to sounder risk management would likely be healthy for markets overall.