Written By: Jeff Boswell
& Ed Evers
Jeff Boswell and Ed Evers of Investec Asset Management discuss the benefits of a multi-asset credit investment strategy for both DB and DC schemes
What is a multi-asset credit (MAC) strategy?
Jeff Boswell: Multi-asset credit investing at its core is around constructing portfolios in an unconstrained manner across the entire credit universe. It’s about looking for the most attractive risk reward across those markets, as opposed to traditional credit investing, which is very siloed in its approach. So what that means is that there is more breadth of opportunities, and importantly from a MAC context, the strategy should be continually, dynamically, evolving to change with market conditions and risk premia, which ultimately gives a better outcome.
What is the difference between MAC investing and traditional fixed income investing?
Boswell: Traditional fixed income investing, and historically the way most pension funds would approach it, is very siloed. A pension scheme would have a high yield allocation, an investment grade allocation, EM credit allocation, a loans allocation etc, with an idea of how each of those allocations is likely to behave in different market conditions. But for the most part you are aiming to capture the beta, and hopefully some alpha, within those markets. Within a MAC portfolio, part of what you are doing is outsourcing that asset allocation decision to the manager. Asset allocation, and getting the timing right, is difficult in any market, and arguably even more so in the current environment. So when is the right time to move out of high yield into investment grade, or even within high yield, when to be out of European high yield and into US, for example. This is really where a MAC manager comes to the fore in terms of taking that decision off the investor’s hands, and removing the asset allocation burden.
Importantly though, the MAC asset allocation decision is often principally driven by the bottom-up attractiveness of individual investment opportunities. In essence the MAC strategy is a best ideas strategy across those different markets, which allows you to build what should be a more robust portfolio.
As with any investment decision, there’s a top down overlay, but what you are looking to do is to capture the best individual opportunities within those individual asset classes.
What are the different approaches to investing in a MAC strategy?
Boswell: MACs broadly fall into three categories. Lower risk, medium risk, and high-octane. For the lower risk MACs, the return targets are typically in the cash plus 2-4% range. Their investors are typically looking for a replacement of an investment grade portfolio, or a lower risk element where you can undoubtedly get the benefits of diversification and sources of return but they are not using it as a significant return generator.
The medium risk version is the MAC strategies aiming for the cash plus 4-6%. Some of these managers work on a total return basis, with an outcome-orientated investment approach, looking to generate their total return with as little risk as possible. Other managers in this space may pull together a hybrid benchmark, eg 50% high yield and 50% loans, against which they manage their strategy. One of the reasons we at Investec follow a total return approach is that we think one of the most appealing features of MAC is that you remove benchmark bias from the equation.
We believe MAC is supposed to be a best ideas strategy, so having some sort of benchmark that you are beholden to makes it a bit more difficult to construct a truly unbiased and unconstrained portfolio. Our MAC strategy invests across all the significant credit markets – investment grade, high yield, loans, EM and structured credit. And being able to do so in an unconstrained manner also means we can use the different behavioural characteristics of subsets within those markets in constructing a more robust portfolio.
Finally, another approach to MAC is more at the “risky” end of the spectrum, trying to generate cash plus 8-10%. These strategies are typically taking more idiosyncratic credit risk, and including direct lending or distressed assets in their MAC portfolios. So MAC managers are trying to achieve different things, depending where they are on the risk spectrum.
What are the benefits of a MAC strategy?
Ed Evers: There are a number of them depending on the type of investor you are. DB pension schemes on the whole are still trying to chase the deficits away by sorting out the liabilities, while also getting growth from their fixed income and other assets. MAC plays an important part of their general derisking approach – which more often than not means selling down equities and buying other growth oriented assets. So if we can achieve cash plus 4-6%, that makes MAC a good equity replacement strategy that is appealing to pension schemes. There are some DB schemes that are a little bit better funded but find themselves in a nasty situation of being cashflow negative, as a result of having too much pension to pay from the yield coming off their ordinary growth and fixed income assets. However, a yield of about 5% per annum or so is quite achievable in MAC strategies, which can help pay pensions or consulting fees or admin costs. One of the things pension funds are needing to focus on now is the seemingly ever-increasing investment opportunity set. I think the pressure on trustees to consider this breadth can sometimes clash with the time they have as lay trustees to understand some new asset class. Packaged solutions like MAC can really help because it can give them access to areas of the credit market that really would need quite a serious governance implication from a typical trustee to be able to do these things directly themselves.
Are MAC funds suitable for DC schemes?
Evers: DC has not moved on over the years, in that there is still a focus on very liquid solutions. Some credit market areas, such as loans, are less liquid or at least have settlement issues compared to bonds. Our MAC strategy has monthly liquidity, so it is DB investors who tend to be interested as they don’t have the daily liquidity requirement. We have found that MAC can have a place within the latter stages of a DC scheme’s default strategy. As the default fund reduces its volatility as the scheme matures, a fund can still generate returns without so much volatility, reducing the risk of wiping out that hard-earned pension pot.
MAC is still quite new for DB schemes, and even more so for DC. So why are MAC strategies becoming more popular now? What has changed in terms of market conditions to make pension funds look to MAC?
Boswell: MAC funds should work in any market conditions because of the flexibility you have as a manager. But I think it is even more appropriate in the current environment given the uncertainty facing investors. Be it an addiction of markets to central bank activity, the unusual nature of this economic cycle, populist politics, geopolitical risk, divergent rate cycles, the list goes ones. We are in unusual times. As a credit manager, having more flexibility and a bigger opportunity set to choose from allows for a lot more potential to generate a better outcome. And that’s the key. Not only does MAC take away the administrative and asset allocation burden from a trustee perspective, it also potentially allows the manager to generate a better outcome in terms of risk-adjusted return no matter the market conditions.