Tim Haywood of GAM shares his latest thoughts.
What changes are you seeing in how pension schemes are utilising fixed income in their investment strategies?
Over the last five to ten years, much has changed in the approach pension schemes are taking to their fixed income allocation.
First, many schemes have directly targeted the management of their interest rate and inflation risk through overlays or LDI funds.
This has allowed them to think more broadly about fixed income’s role – in particular its contribution to returns as well as to portfolio stability.
As a result, they have expanded the sectors and allocations they permit, moving beyond gilts or sterling corporates to include overseas bonds, currencies, high yield, emerging market debt and even convertibles.
Second, many schemes have reconsidered their fixed income benchmarks, in particular, moving towards a cash benchmark such as Libor as absolute return bond strategies become more popular.
Strategically, Libor fits better with liability overlays and the broader return-seeking role for bond mandates and, tactically, traditional benchmarks are likely to underperform cash if interest rates rise.
Are you seeing much evidence of schemes segmenting their fixed income allocation and employing specialist managers to manage each separate segment?
Yes. Schemes are taking greater control of their sector allocations and appointing specialist managers.
This means more appointments not only to high yield and emerging market debt managers, but also to convertible bond, bank loan and distressed debt managers.
A desire for greater control of sector allocations has also led some larger funds to split their investment grade allocations between global sovereigns and global investment grade credit.
Alongside this, we are also seeing schemes widen the remit of multi-strategy fixed income managers to include all sectors.
These mandates, being either absolute or total return-oriented, are designed to efficiently provide long-term outperformance of cash by being flexible to focus on the best opportunities with little or no regard to traditional benchmarks.
What are the issues that need to be considered before taking such an approach?
The starting point for any investor is to consider the objectives for their whole fund. If investing in liability overlays or requiring a contribution to the portfolio’s returns from their fixed income allocation, then they need to think a little differently about their fixed income manager.
A flexible multi-sector fixed income approach needs not only deep expertise within each sector, but critically, they also need robust top-down allocations and familiarity with portfolio construction and modern techniques.
These competencies come only from experience; therefore they should be wary of simply expanding existing managers’ mandates, without testing them against managers with a proven record in these approaches.
What is the outlook for fixed income over the coming six months?
Bond yields in many major markets are at or close to multi-decade lows, thus cramping future return prospects.
When compared to current economic data of low growth and sticky inflation, core government bonds do indeed look expensive.
In absence of political leadership, Central banks have reacted with a range of noteworthy measures that will provide a floor to bond prices.
After the summer swoon, many spread products currently offer very attractive prospective relative returns, but we feel that the high probability of one, maybe two sovereign debt restructurings in Europe in the coming months and the associated market conditions may keep spreads volatile before re-tightening.
The lack of powerful growth in most countries provides a frail banking canvas upon which to paint a raft of de-leveraging and defaults.
For this reason, the limited incidence of defaults of sovereigns and large banks could continue, with the less-immediately painful option taken of money creation, capital injections, fiscal transfers and enforced mergers.
This socialisation of debts and bank capital, courtesy of the printing press, risks potential future inflation and skewed capital markets.
Tim Haywood is investment director, fixed income at GAM, responsible for $12.7bn (£8bn) in absolute return bond mandates.
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