An allocation to multi-asset credit can bring default portfolios more in line with the needs of today’s plan members, who are increasingly looking for options to stay invested up to and through retirement. Particularly in the mid phase of the glide path, where default strategies are often dominated by passive equity funds and diversified growth funds, right through to the late phase, when default portfolios tend to be dominated by gilts and cash, plan members may be missing out on access to the attractive returns, diversification and downside protection that a multi-asset credit strategy can provide.
A MORE APPROPRIATE GLIDE PATH
A typical DC default strategy begins to diversify away from equities in the mid phase of the pension glide path using diversified growth funds (DGFs), and by the late phase can be invested only in gilts and cash. The purple line in the chart below shows the expected volatility and returns for a typical default allocation across the glide path, while the grey line shows the most efficient allocation using traditional allocations over time for DC plan members who choose a drawdown option at retirement.
The blue line shows how risk-adjusted returns can potentially be improved by introducing a multi-asset credit allocation alongside an allocation to equities and DGFs, from the mid phase of the glide path right up to retirement. This analysis suggests that introducing an allocation to multi-asset credit, starting in the mid phase of the glide path through to retirement and beyond, could be more appropriate for the needs of today’s DC plan members.
Adding a multi-asset credit allocation can produce higher expected returns and lower expected volatility compared to more typical default strategies, which provide members with high quality assets in the lead-up to retirement, but can have relatively low expected returns and a high sensitivity to interest rate risk. For plan members going with drawdown, it could make sense to invest in a more diversified default portfolio that has the potential to earn higher riskadjusted returns throughout each stage of the pension glide path.
MULTI-ASSET CREDIT STRATEGIES CAN LEAD TO BETTER MEMBER OUTCOMES
Multi-asset credit strategies provide an attractive combined credit solution for DC plans looking to diversify existing default strategies, particularly if they do not have their own in-house capabilities to effectively manage allocations to the various credit components (high yield, investment grade, emerging markets) individually.
Multi-asset credit managers with a truly global footprint are often best placed to take advantage of the opportunity set. Although top-down sector allocation and duration positioning forms a crucial component of portfolio construction, the ability to draw upon locally based resources across key global markets enables portfolios toalso incorporate bottom-up security selection to build the optimal portfolio.
Three ways that DC plans can benefit from credit exposure
Multi-asset credit strategies provide access to the attractive returns offered by global credit markets by allowing fund managers to seek out alpha opportunities across the credit spectrum, while also managing downside risk by adapting sector and duration positioning as market conditions change.
Sector and duration positioning is actively managed through the market cycle
Source: J.P. Morgan Asset Management. For illustrative purposes only.
Unconstrained credit makes DC fixed income allocations work harder
Multi-asset credit funds use flexible sector allocations and rigorous security selection to capture attractive returns with less volatility than the highest beta credit and fixed income sectors.
Top-down research reveals the investment themes that are impacting credit markets at any one time, providing a guide for managers when deciding on the optimal allocation across the various credit markets and sectors.
Security selection within sectors is then driven by bottom-up analysis of individual companies. The ability to pick winners and avoid losers is particularly important at this later stage in the market cycle as volatility rises and the dispersion in returns between sectors widens.
Additionally, unlike benchmark-oriented fixed income portfolios, unconstrained credit funds can position their duration exposure based on prevailing market conditions.
This flexible duration positioning could be particularly beneficial in the current rising rate environment, where the return from fixed income duration is likely to move from being a strong positive contributor to total returns to a negative contributor.
The ability of flexible multi-asset credit funds to dynamically shift corporate credit allocations and interest rate sensitivity throughout the market cycle can help DC plans to improve the overall risk-adjusted return profile of their default strategy.
Dynamic credit can capitalise on more alpha opportunities while limiting risk
Benchmark-oriented credit strategies can force portfolio managers into allocations and positioning that may not necessarily fit with their investment thesis. They may have a strong conviction on the direction of interest rates but they cannot move too far from the duration of their given benchmark.
Similarly, they may have a negative view on a specific sector in the benchmark, but will typically still have some exposure as performance is evaluated relative to the benchmark.
An unconstrained approach gives managers the freedom to express their views. If they do not like a sector or a name, they don’t own it. This flexibility enables managers to react quickly to risk events and take advantage of opportunities across the full corporate credit universe as they arise.
Although managers have the freedom to invest in their favoured segments of the market, all of this can be conducted within a robust risk management framework that ensures risk is managed within pre-defined limits.
Diversified credit exposure can produce a smoother investment journey for DC members
Dynamic asset allocation, diversification and hedging strategies all contribute to the ability of multi-asset credit funds to produce attractive returns and favourable drawdown profiles relative to single asset classes.
Multi-asset credit funds have the ability to dynamically adjust their asset allocation through every stage of the market cycle to ensure that investors have exposure to the best performing segments of the credit markets at any point in time.
For example, investment grade corporate would be expected to outperform other segments of the credit market when an economy is in the contraction phase of the market cycle, while a higher allocation to high yield may be beneficial in the recovery phase of the cycle.
Diversification plays a key role in producing high quality returns. This can be achieved by accessing a truly global opportunity set, including both developed and emerging markets, allocating across different asset classes and taking exposure to a wide range of companies and sectors with varying business models.
Hedging strategies can also be deployed to help limit periods of drawdown. Credit risk can be managed through derivatives that act as a form of insurance on asset classes or individual names, while interest rate risk can be flexibly managed lower in times of rising yields as a way to protect total returns.