Partner Insight: Diversification, a stable source of cash flow and expected returns in excess of expected defaults are among the benefits, says Martin Reeves, Head of Global High Yield at LGIM
One benefit I'd highlight is the provision of risk-adjusted returns. If you look at the returns that have been generated relative to the historical default experience, and expected default experience, they look very attractive, in our view. What we expect going forward is that pension schemes will be overcompensated for the expected defaults.
We believe that alternative credit asset classes are worth owning and we're fortunate that here at LGIM we have two world-leading teams in terms of fund managers. Our approach in general is to be diversified and perhaps this is one of the things that some trustees don't quite get; that high yield and emerging market funds are nowhere near as concentrated as you might find in an equity portfolio. So the funds are generally well diversified. We aim to attract a beta component as well to make sure we get a nice steady flow of income.
We're also aware of what our downside can be. If you can manage your downside, then you can improve returns. But again, if we're being active, we're going to be dynamic and if we think we're going into a default cycle, we're going to change the profile of the companies we buy. And if we're in a good part of the cycle, we will be buying slightly different companies that we expect to improve returns and bolster the income during the cycle that the pension funds can invest.
That's why we don't think buy-and-maintain works in high yield, because you have to be looking forward six to 12 months and thinking ‘what is the right way to have the portfolio positioned for any forthcoming change in markets?' We expect this dynamic approach of being diversified and understanding what the downside is, to improve risk-adjusted returns.
Click here to learn more about the strategic benefits of alternative credit and how it can improve investors' risk-adjusted return profiles