A slump in government bond yields has caused some defined benefit schemes to delay derisking and look for greater returns in more volatile assets.
Ten-year UK gilt yields dropped further to around 2 per cent last week, down from 2.7 per cent in June and 2.9 per cent at January 6 this year.
Within the bond space, this has meant some schemes have turned to high-yield debt as well as emerging market debt in the hope of extra income.
Tapan Datta, partner at consultancy Aon Hewitt, says for schemes, investing in high-yield debt has been painful due to its more volatile nature.
“It’s really a reflection of some [concerns] around how long spreads have become in the US and the market is vulnerable to a sell-off,” says Datta.
The fact that high yield is prone to fluctuations in the economy and more aligned with equities than some other bond assets also increases the inconsistency of returns.
And there is concern a bubble has developed within the market, with inflows into high yield depleting potential returns for investors.
Data from Financial Times service MandateWire showed in the first quarter of the year European institutional investors sold £5.3bn of gilts and invested £445.7m in high-yield bonds and £8.5bn in corporate bonds.
Datta notes: “When things become more expensive then it’s more likely you’ll be hit by volatility.”
He adds schemes can manage this by investing in multi-asset credit solutions or alternatives such as direct lending opportunities.
Leicestershire County Council Pension Fund is one such scheme, allocating £100m to direct lending opportunities.
In Pensions Expert’s The Specialist report earlier this month, Colin Pratt, investment manager at the scheme, said: “We just felt that this was a better opportunity in terms of investment returns, given the type of environment where bond yields are more likely to rise than fall.”
Gaining yield from the emerging markets
Emerging market debt, which has experienced its own volatility, is still seen by consultants as preferable to high yield, however, this area has become more expensive for schemes to invest in.
Giles Payne, director at HR Trustees, says trustee boards he sits on have shown interest in these types of assets, despite the fact they can be volatile.
“In terms of managing it, certainly if you want to invest in these high-yield areas people are looking more towards these diversified credit vehicles or absolute return funds,” he says.
