Experts call for smart beta credit to meet diversification demand

Schemes have been broadening their credit investment universe, which includes multi-asset credit and senior loans, to take advantage of higher yields and soften the blow of low yields on government bonds. 

A recent survey by consultancy bfinance found 59 per cent of schemes plan to be exposed to alternative indices in the next year. 

While alternative strategies for the asset class already exist for pension funds, some industry professionals have said more effort needs to go into establishing smart beta indices in order to get the full benefit of the approach. 

“An index provider needs to produce investible versions of the strategies in the form of indices,” said Andrew Clare, professor of asset management at Cass Business School. “There is a big opportunity for someone to lead on this.” 

Many schemes now have equity weightings of between 5 and 10 per cent, so the argument about the equity index or benchmark schemes use is less relevant than it would have been 10 years ago, Clare said.  

He added: “Fixed income benchmarks and indices, and getting those right, are far more relevant for the future than getting equity indices right.” 

Helge Kostka, European vice-president at investment research company Research Affiliates Global Advisors, said schemes' increasing familiarity with smart beta equity strategies means the uptake of such indices will be quicker in the fixed income space.

"[This is] simply because the positive experience they have enjoyed in stocks makes them more open to opportunities that exist in other asset classes," he added. "Some investors may require long track records and want to see others move first, but a few will take the risk to be an early adopter."

Financial adviser Rothschild is funding a project with index provider Edhec-Risk Institute to look into ways in which research into smart beta credit can be improved, as interest from larger pension funds has risen.

Thibaud de Vitry, general manager of the adviser's risk-based investment solutions, said there has been increased interest over the past year for fixed income risk-based solutions from some schemes. 

"In response, a number of investment solutions across different asset classes, including credit, have emerged. These risk-based solutions aim to cover more efficiently the liability structure of a pension scheme," he said.

He added that academic research within smart beta is not progressing as quickly in fixed income as it is for equities. "Due to the nature of instruments, the barriers to entry [are] considerably higher," he said.

Francis Chua, investment consultant at JLT Employee Benefits, said the increasing need to “sweat your assets more” to achieve better yields and manage risks is already leading some schemes to restructure their corporate bond portfolios towards such buy-and-maintain strategies. 

“There is a wide range of approaches being adopted thanks to greater financial innovation, and easier access [to] smart beta strategies have certainly helped attract attention to this space,” he said. 

‘Dissatisfaction’ from schemes 

Tim Gardener, head of the institutional client group at Axa Investment Managers, said¹ schemes are showing interest in such strategies as a result of a “dissatisfaction” with both active and passive management of credit portfolios. 

Axa has more than £1bn in third-party assets invested in its smart beta credit strategy. Gardener said the costs inherent in rebalancing traditional passive fixed income strategies at certain times can damage returns, and transaction costs have “undeniably increased”. 

He added: “Buy-and-hold approaches mean you don’t sell downgraded stocks unless they are going to default, and use coupons and maturities to rebalance portfolios, but otherwise avoid selling securities.” 

Gardener also said smart beta credit could play an important role in the defined contribution market following the Budget’s announcement on annuities, as it will help trustees control costs. 

“Now that annuities are not required, income products like this will become more important. Smart beta in fixed income can provide stable cash flows with returns likely to be above government bonds,” he said.

¹The original version of this article stated: "Tim Gardener, head of the institutional client group at Axa Investment Managers, said despite any perceived lack of research, schemes are starting to show interest in such strategies as a result of a “dissatisfaction” with both active and passive management of credit portfolios."

In fact, he said this interest had already started, and made no mention of the "perceived lack of research" discussed elsewhere in the story. This has since been updated.