South Yorks ups property, EMD and high-yield in search for returns

Schemes have increasingly looked to diversify their bond portfolios as well as looking to more illiquid assets in a search for yield and longer-term growth.

The £5.6bn fund has placed greater emphasis on emerging market and high-yield debt within its bond portfolio.

Its holdings in index-linked bonds were reduced to £580m at March 31 2014 from just over £610m the previous year, according to its most recent annual report and accounts.

John Hattersley, fund director at South Yorkshire, said: “The yields are at historically low levels and we have got to be prudent, and [we] have seen expectations of where yields will go to eventually, so we don’t see any real reason to be committing ourselves to long-dated index-linked bonds."

It has a combined allocation of 4 per cent to both asset classes, with holdings valued at £170m at March 31 this year. 

Hattersley said the scheme controls levels of volatility that can result from emerging market and high-yield debt by undertaking assessment of the credit risk and having “strict controls” in place as to how much money it allocates to these types of assets.

Tapan Datta, head of global asset allocation at consultancy Aon Hewitt, said currently most liquid asset classes are not cheap.

Datta said emerging market debt still looked like a reasonable buy, but high-yield debt is particularly vulnerable to a sell-off.

“It’s partly risen at the moment because high-yield has been a victim of the fact it’s been particularly popular recently,” said Datta.

The scheme also slightly increased its allocation to overseas equities to 40.3 per cent at March 31 2014 from 39.4 per cent the previous year, as it believes the asset class is a source of growth, Hattersley said.

Datta said ideally schemes should have reviewed their equity holdings around 12 to 18 months ago.

He said another drawback of high-yield debt is “when equities were tanking, high-yield performed quite poorly”.

However, he added: “The correlations^¹ are an issue but high-yield is picking up other implications such as interest rate risk.”

While many illiquid assets such as property and infrastructure are a source of long-term growth, schemes could also look to hedge fund options such as global macro or managed futures, said Datta.

The scheme also increased its allocation to property to 10.7 per cent of assets, from 9.2 per cent at the same time the previous year, according to its annual report.

Speaking at the scheme’s annual meeting, Hattersley said it put more money into property due to the belief neither fixed income nor equity markets were fully pricing in the potential downside risks.

“We also put money in when it became clearer that the recovery in property was not just limited to London and the southeast,” said Hattersley. 

Simeon Willis, partner at consultancy KPMG, said while secondary property can be a source of growth for a scheme’s assets, its risk profile is on a par with equities.

“They tend to be quite concentrated portfolios; there’s active manager risk and there can be a reasonable amount of leverage as well,” he said.

Other assets, such as direct lending to medium-sized businesses, are still reasonably priced opportunities open to schemes looking for growth, he added.

Earlier this year, the West Midlands Pension Fund set aside £40m for a direct lending fund to provide finance to small and medium-sized businesses in the Birmingham area.

^{¹The original version of this article misquoted this word as "correlatives".}