DC funds must move away from passive corporate bond allocations

Fixed income remains a vital part of DC members’ at-retirement investment portfolios, often ranging between 30 to 60 per cent of the default strategic asset allocation for large master trusts and single trusts. 

Within this, passive UK corporate bond mandates form a large part — an approach Axa IM claimed to be ineffective for meeting member needs.

A more global focus with the ability to implement climate-aware objectives would improve member outcomes by providing both steady income and stable growth opportunities, the asset manager stated. 

It argued that while the spread and average credit rating for UK and global corporate credit indices may be broadly the same, the expansion of the investment universe achieved through inclusion of the US and EU markets has huge implications for both the liquidity of the bonds held and the diversification of risks.  

Higher liquidity would reduce trading costs which, while not being shown directly in fund performance, could positively impact a credit portfolio that is being used for regular drawdowns in retirement.

Additionally, a greater level of portfolio diversification across issuers and regions should reduce volatility and drawdowns. 

Axa IM also pointed to structural concerns of a passive approach, with the structural bias to lending the most money to the more indebted sectors and issuers not representing a prudent way to allocate money.  

It argued that a more blended approach — such as a buy-and-maintain credit strategy, which seeks to use the same fundamental credit research and skills as active management but with the low-cost edge of passive management — can overcome these issues.  

Sebastien Proffit, head of portfolio solutions and fixed income at Axa IM, said: “DB pension funds and insurance companies have been moving away from passive UK corporate bond allocations in recent years.

“They have recognised the structural shortfalls, lack of flexibility and material negative impact that turnover costs and forced selling can have on strategy performance, yet these allocations remain a mainstay of many default designs in DC pension portfolios.

“We are encouraging UK DC schemes to reconsider this approach and think about how this important allocation can be improved.” 

Proffit continued: “Diversification, liquidity and more stable performance can boost returns for members, as well as reducing the dispersion of performance between them.”

Outlining the benefits for DC schemes and members to switch from a passive UK to a global corporate bond allocation, he said: “The sterling corporate bond market has had consistently higher levels of volatility compared with the global credit market, which can create a larger risk for individual members when they are drawing cash in retirement.

“At a scheme or trust level, this could lead to greater distribution of returns between different members, depending on when they decide to draw income.” 

Proffit added that even when looking at index allocations, expanding DC members’ universe from UK to global corporate bonds could increase the stability of returns for members by accessing a much broader universe of issuers and a more balanced allocation of risks.