To get the most out of a low yield environment, many pension funds have allocated to multi-asset credit strategies over the past few years. Has this trend continued in the Covid-19 environment? 

 

The government taking on debt to support the economy during Covid-19 have dealt a blow to any hopes that interest rates might go up in the shorter term, despite an expectation that inflation will rise. As a result, even more defined benefit pension funds are pushed ever further into less traditional types of fixed income and strategies that can offer access to these. 

 

 

Multi-asset credit has “somewhat come out of the woodwork in the last year or two” as traditional investment grade bonds and government bonds are not yielding enough for schemes, says Gerald Wellesley, a client director at Punter Southall Governance Services. 

 

“The idea of multi-asset credit is quite attractive because people are also nervous about equities,” he adds, noting that some of the other alternatives to equities are often in the illiquid space. Multi-asset credit funds are a good option for schemes to achieve a better yield in the fixed income market than schemes might otherwise achieve while still staying out of equities, he argues, and offer diversification across a number of income classes. As such, the strategy has become “a bit of a cornerstone” of many scheme portfolios and often comes up in discussion with DB trustees, he says. 

 

Given the underlying asset classes in the strategy – which can include high yield bonds, loans, convertibles, emerging market debt, asset-backed securities and in some cases investment grade bonds – “the issue of course is [that] they are riskier”. With this higher risk, an allocation of 10-15% “feels about right”, says Wellesley, which would be sitting alongside allocations to more traditional fixed income and potentially infrastructure or other alternatives. 

 

High yield / loans spreads (US and EU) 

 

 

Not every trustee is equally convinced of the benefits of multi-asset credit, however, and some believe its popularity might be waning. Natalie Winterfrost, a professional trustee at LawDeb Pension Trustees, says one of the problems for trustees with multi-asset credit is that it requires “giving up control of risks trustees might wish to manage” – not just interest rate and credit exposure, but also exposure to currencies and liquidity, which in such strategies are “all bundled up in there”. There would therefore need to be a “convincing argument that managers can add value” for trustees to hand this control over, she feels. 

 

With DB schemes required to set a long-term funding objective in the draft DB code – essentially low dependency or buyout – trustees’ thinking is also increasingly focused on how investments can support this goal. Credit is seen as part of the solution for this, rather than as a diversifying growth asset, Winterfrost says. 

 

With increasing maturity and derisking, cash flow is front and centre for trustees, and where schemes use a liability-driven investment overlay, the mechanics of a buy and maintain approach might fit more easily with this need, she argues. “You can show this to your LDI manager and it can all form part of holistic solution,” she says, while multi-asset credit “might not fit so well in that structure”. 

 

However, for schemes that are less far down their derisking path, multi-asset credit can offer an intermediate step between equities and gilts. Smaller schemes that are still growth heavy and lack the resources to have separate allocations or oversight of all the risks can find multi-asset credit useful as they offer a way for them to access these asset classes, she says. 

 

Performance has been varied but has not been a real disappointment. “Everyone suffered as credit spreads blew out,” she observes, and so it is understandable that credit funds felt the effect as well. “No one expected MAC funds to go into cash, they are credit vehicles. They might have disappointed some trustees, but one can’t blame managers for the performance in 2020,” she adds.  

 

 

On the whole, it appears that interest continues to be strong. Local authority schemes, which are less mature than most private sector DB schemes, are among those that have invested in multi-asset credit funds – or are doing so now. 

 

“If they didn’t already have MAC exposure... they’ve been making that allocation,” says Anthony Fletcher, a senior adviser at MJ Hudson Allenbridge. “If anything, it’s been a bit slower than otherwise they would have done, because of pooling.” 

 

There are many ways to do multi-asset credit, with some fund houses covering the whole universe including both investment and sub-investment grade issuers, but “the approach that is probably more appropriate for MAC is predominantly or totally sub-investment grade”, as most pension schemes already have an exposure to investment grade corporate bonds, says Fletcher. 

  

Across the client base of consultancy Mercer, multi-asset credit continues to be one of the areas of high search activity, perhaps the most active in 2020 when looking at actual client projects and manager searches, says Noel Collins, partner and fixed income researcher. Having come to the fore from about 2012 and 2013 onwards, the strategy still delivers for clients and now has a good track record, he argues. 

 

“Some people had maybe hoped to go from equities straight into defensive assets, but because yields have been so low for so long, they see that that move can be a bit too extreme [in terms of] the impact on return expectations,” he says, describing multi-asset credit as a kind of “middle ground” between equities and low risk assets. He says an allocation of 15-20% is typically made by schemes choosing to invest in this strategy, and schemes tend to pay medium fees of about 50 basis points depending on the complexity and return target of the particular strategy. 

 

While multi-asset credit fell sharply in the first quarter of 2020, it fell by less than equities did and has recovered the losses since. “The derisking story did play out,” says Collins. 

 

 

How multi-asset credit funds reacted this year also depends on the underlying assets, as there is considerable variation among managers. “That is quite neat in a way because it means clients can pick and choose with a fair degree of accuracy where they want to go on the risk spectrum,” says Collins. 

 

However, “the flipside is that it’s a more complex category in general, you have to understand the array of asset classes generally available and decide, ‘Do I need all of these or do I need a subset, do I need to be return-chasing or defensive’”, he adds. 

 

The heterogeneity of multi-asset credit strategies means trustees looking to invest need to understand whether they are aiming for some extra return or for something more conservative. “If you have an idea of what you’re coming to do that would be a good start,” he recommends. 

 

Next, trustees will need to get a high-level understanding of the asset classes that go into multi-asset credit – from high yield, loans, emerging market debt, asset-backed securities and convertible bonds to investment grade credit. “Try and know what the asset classes are and where they sit in the global landscape of investment, but don’t feel you need to know them all in depth, or you might lose the wood for the trees,” advises Collins. 

 

Lastly, he says trustees should try to understand how managers work. “All it comes down to is having an idea of how does a manager put the asset classes together and invest in each asset class? If you come away knowing manager one is more top down, manager two more bottom up... that will help you compare more easily,” he says. “If you do these three steps, that will get you a long way to any decision to allocate to MAC and a selection exercise.” 

 

 

Much about the decision to invest depends on an individual pension fund’s circumstances, however. 

 

“We have had clients who are looking to achieve a higher return by reducing exposure to government bonds in favour of MAC,” says Craig Scordellis, head of long-only multi-asset credit at asset manager CQS. Other schemes, perhaps closer to full funding, are looking to reduce volatility while maintaining an attractive return profile, adding to multi-asset credit out of equities.  

 

Scordellis adds that a number of the firm’s clients have added to their multi-asset credit exposure during the pandemic, reducing allocations to areas like emerging markets and private equity “where visibility is often limited and sensitivity to defaults may be high”. 

 

He expects default rates to peak in the first quarter of 2021 but notes that exposure to these can be avoided because much of the risk is already known – with sectors like travel, leisure and hospitality among the most likely to suffer, whereas financial issuers like banks are expected to fare better. Given that inflation could pick up, the asset manager also prefers floating rate instruments over fixed income. 

 

 

When selecting a manager, Scordellis advises trustees to consider the size of the investment house. "If a MAC manager is to be successful, they need to be selective and to be nimble. For the very largest managers, are they still able to do that, or are they essentially buying the market? If they are very small, what sector expertise are they able to bring, and do they have the scale and relationships needed to access the right opportunities?” he says. 

 

To help capture these opportunities, managers should also analyse underlying investee companies based on environmental, social and governance factors. ESG is already “essential” to evaluating the probability of default, he says. However, ESG integration is no longer just about risk assessment and avoiding the downside, he argues, but about exceeding return targets and doing so responsibly. 

 

This means engaging with underlying companies. “Engagement is key and makes it clear that responsible investing is important to us and we seek long-term change in behaviour,” he says.