By Peter Martin
As we approach 2015 and take stock, pension funds should now take the opportunity to re-assess how they can achieve a sufficient return in today’s paradigm of lower yields, tepid returns from investment grade credit and ‘tight’ credit spreads, plus the prospect of increasing interest rates.
Pension funds need to have a plan in place to navigate the unchartered and potentially choppy waters ahead. Responses though, will clearly very much depend on individual scheme’s circumstances, objectives and risk appetite. Pension funds should be considering some of the following investment opportunities throughout 2015
– To maintain a sufficient return, pension funds should consider how to ‘work’ their bond assets harder and smarter in order to find attractive risk-adjusted yield. This can perhaps be achieved through the adoption of dynamic and nimble multi-asset/sector approaches to credit and by the increased use of the panoply of opportunities, which exist outside of the universe of traditional sterling investment grade bonds (i.e. high yield, emerging market debt etc.). But the journey into these lesser ‘constrained’ mandates should be undertaken in a considered and measured manner with delegation to skilled managers in this space in order to source the ‘alpha’ and to manage the increased governance and ‘complexity’.
– 2014 has been, in a number of respects, the year of the ‘MAC’ (multi-asset credit) and for many this can be an appropriate solution for generating yield from fixed income and engaging with the less ‘familiar’ credit assets. This trend is here to stay for 2015 and beyond.
– To protect the capital value of the matching portfolio in the context of potentially rising yields/interest rates, pension funds will look to invest in ‘true’ absolute return bond funds (ARB) with limited drawdown, as well as other senior secured loans/other types of floating-type product. Such ARB type products can be increasingly expected to be judiciously used as part of the liability-driven investment (LDI) solution, as they can form an alternative to cash based options to fund the derivative exposure.
– Consider the illiquid and potentially ‘complex’ credits. Pension Funds are in an ideal place to reap the illiquidity premium available from private illiquid debt. Pension funds can and have been the suppliers of capital for direct lending, senior real estate debt and senior infrastructure debt investment, positioning themselves today to participate in the long term cash flows and the attractive risk-adjusted returns that these can offer.
– Investment in ‘try and hold’ portfolios is another trend seen in credit whereby investment is made in bonds, but on a buy and maintain basis. This is largely a reaction to the reduced liquidity seen in corporate bonds (given the reduced warehousing of bonds by banks) and the increased transactional costs of dealing. Strategies may aim to beat a market index whilst others invest in order to cash flow match the pensioner liabilities.
– Inflation protection is perhaps not a credit solution but inflation hedging is worth considering. Arguably market conditions have recently been more conducive to putting in place inflation hedging protection than in previous years. Some investors could choose to react to the current low level of nominal yields by instead looking to put more inflation protection in place (possibly through ‘leveraged’ vehicles).
The (r)evolution of pension funds’ approach to credit will continue through 2015 and beyond. It is after all a brave new world…
Peter Martin is head of manager research at JLT Employee Benefits
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