Blair Reid looks at how multi-asset credit can help pension funds through the economic crisis provoked by the pandemic.
The early twenties was a golden era for multi-asset credit (MAC) with multiple investment funds launching to meet growing demand. Particularly popular amongst UK defined benefit (DB) pension schemes with the investment strategy complementing their de-risking journey.
However, conditions have changed considerably since then. Central banks and governments have released tremendous amounts of market support in response to Covid and this in turn impacts asset prices. While in the long run assets always find their ‘right price', in the medium term opportunities will likely shift more sharply between different parts of the credit market.
As such, these DB schemes would do well to re-assess how they approach their MAC strategy. In our view, casting a wide net is one way of responding to what may be a multi-year, stop-start economic recovery.
No amount of government support can fully compensate for the global economic impact of Covid and its aftereffects will be with us for a long time. Even if a vaccine is found in the short term, behaviours and perceptions have changed with significant consequences: working remotely is now a viable option for many (and often preferred), a lot of businesses can operate surprisingly well virtually, buying online is beating bricks and mortar, business travel is much curtailed, international holidays may be fewer and so on. In time, it may even mean rethinking transport systems and the role of cities if the short-term trends gather momentum.
For pension funds two things come to mind: one, there will be rising defaults in parts of the market negatively exposed to these changes; two, flexibility may be the key ingredient to future success.
The previous financial crisis was the catalyst for greater flexibility in credit mandates where, as is the case today, government and central bank support impacted asset prices and the role of navigating a safe path was delegated to investment managers. MAC grew in popularity and the Covid crisis presents a similar set of circumstances for investors: asset prices impacted (mostly inflated) by central banks; risk free rates near zero or negative.
The added complexity this time is changing behaviours, some irrevocably, which in our view will see, among other things, industries that facilitate remote working benefit and close proximity activities suffer.
Static allocations to credit markets can serve pension funds well when the world is broadly static - they serve them less well during a transition phase. The same can be said for index-tracking credit strategies, particularly as defaults rise.
The reality is nobody knows what the next few years holds, but a flexible approach at least allows pensions funds and/or their asset managers the ability to fully react to change.
Working harder to get returns . . .
In many countries the ten-year government bond yields are lower than inflation expectations, so investors expect to lose in real terms. For DB pension funds this may have less of an impact, though for most investors avoiding loss remains a key objective.
Earning, say, cash plus 3-6% in the credit market today requires investors to buy largely sub-investment grade bonds. That comes with attendant credit (default) risk. In many ways it makes sense for investors to provide greater flexibility where there is greater credit risk. It allows the manager to rotate into and out of opportunities.
MAC - what asset classes to include?
There is a wide spectrum of MAC products out there from ‘narrow MAC' which includes just a few asset classes to ‘go anywhere MAC' that does just that. At the current juncture we believe a wide net conveys some advantages. These are both structural and asset class specific and include:
- Zero weight - more asset classes provides greater ability to have zero exposure - with plenty of asset classes to choose from, a manager can more easily to have potentially zero exposure to parts of the market. This is harder when fewer assets are included.
- Diversification - a more diversified MAC exposure is simply less susceptible to unexpected central bank/government interventions which can have asymmetric impacts on specific asset classes.
- Convertible bond universe is ‘Covid friendly' - pharmaceutical companies and tech businesses tend to issue convertible bonds and including this asset class gives the manager the ability to access some of the possible winners arising from the crisis. There has been tremendous issuance in recent months with many companies that have never issued a convertible bond attracted to the asset class.
- Cocos (financial capital bonds) - this asset class is unique in that they are hybrid instruments and in certain circumstances investors may not receive a coupon or may suffer a principle loss if a bank's capital level falls below a predetermined level. In effect, an investor is selling an option to the bank/regulator, and in our view being paid handsomely to do so. Given the amount of government support for banking institutions - they are largely the conduit of any recovery - in our view this asset class presents some very interesting opportunities and is one expression of the theme of staying close to parts of the market that directly benefit from central bank support.
- Developed market investment grade - within our own flagship strategy we had not purchased any developed market investment grade in seven years (due to low yields). That changed in late March and April when investors could potentially achieve three or four times the average spread and, although clearly a very sporadic tactical opportunity, the ability to capitalise on unexpected opportunities favours a wide net.
Blair Reid is partner and senior portfolio manager for multi-asset credit at BlueBay Asset Management
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