Roundtable: Where does value lie in fixed income markets?

Dinesh Visavadia: There is a mindset shift that has happened, which is great. Since the 2008 crisis, the value of the fixed income markets in people’s minds has gone up quite a lot. Up until then, it was all about equity.

Anthony Fletcher: But because we have had 10 years of low rates, effectively all yields are too low. So as government yields rise, all of those other yields need to rise to some extent. It is a question of how much they rise and whether it takes away some of the return you are getting from those assets.

Edward Farley: History shows that if government bond yields rise very gradually, as is expected, then often you see spreads compress. Generally, yields going up means economic growth is favourable. On the flipside, an unexpected sharp interest rate rise might push the market into panic mode and spread product could massively underperform. However, these are all policy areas that are slightly untested because we are in a different situation post-quantitative easing.

Fletcher: Interest rate risk is the thing we need to really, really worry about. You can quantify the idiosyncratic risk and the credit spread risk by doing the homework on the issuer. By having shorter duration in your portfolio, if you do get that shock rise in yields that you were not anticipating, you can let the bond mature. If you have a government bond portfolio with 20/30-year duration, you could get really badly hurt by unexpected moves in bond yields.

Sophia Heathcoat: I think that is why we are seeing a lot more demand for floating rate products, loans, things like that. If yields do start to rise then you get the benefit of that there.

The requirement for yield has pushed investors into private markets. There is nowhere else they can generate that level of yield.

Graham Wardle: The banks have pulled out of the private markets as well, which was the main driver.

Fletcher: There is some evidence that we might be about to turn that circle and that the banks have enough balance sheet space to re-enter. That makes me wonder whether I had better get a move on and buy this stuff before the banks start to park it on their balance sheet again.

Alexandra Martinez: We need to ask what the illiquidity premium is on private lending and others, which were very popular, especially two years ago. Maybe we should think about other products? A lot of people are looking into emerging market debt. What do you do with EMD, is blended still the preferred flavour?

Fletcher: Let the fund manager make the decision. I would go unconstrained.

Martinez: EMD has been around for quite a long time, and I think there is still a lot to be made there. However, to find that skillset in a manager that has that experience in special situations, distress, etc. requires due diligence. I am not convinced by the forex-based short-duration, opportunistic approach – if you want to have a long-only EMD product, that is not what it should be.

Fletcher: There are EMD managers out there who have very long track records. However, still EMD only forms about a quarter of the emerging equity exposure. Everybody is very happy to go out there and buy emerging equity but they are very uncomfortable with emerging debt.

Martinez: There is a perception of being more illiquid and more risky. You can vote with equity, unlike with EMD.

Farley: Schemes should ask themselves what their objective is. There are lots of attractive multi-asset credit products, with managers setting really ambitious targets, but you do not get to ambitious targets without taking a whole chunk of risk. It is unlikely to be the main part of the portfolio. One of the asset classes that we try to add when a client has any flexibility is high-grade structured products.

Fletcher: That market has been tempered by the financial crisis.

Martinez: Similarly in the US, you have the residential mortgage-backed securities products, which are very healthy still. It is a shrinking market because it is getting to maturity but you still see some healthy spreads.

Farley: Our experience is that a lot of the UK schemes are moving towards cash flow matching. You cannot use mortgage-backed securities for that.

The same is true of collateralised loan obligations. All of these opportunities are superb ways to add value to a scheme but they need to be considered in conjunction with the key decisions around liability-driven investment – whether to use a manager who just uses government bonds and inflation hedging or build a core investment grade corporate portfolio and have the LDI manager hedge out inflation. It is fanciful thinking to say that you can do that through a diverse section of corporate bonds and inflation hedges.

Wardle: I must admit I am getting a bit worried about some of these covenant loan products that are coming out now. I think: ‘Here we go again.’ I accept that they can be bulletproof, I am just a bit worried that managers are pulling back from that risk-averse process.

Fletcher: That is where you have to have a fund manager that has the courage to look at the market and say, ‘There is no value in this stuff, there are too many covenants being removed. I therefore have risk I did not want to take, so I am not going to take it’.

To add to what Ed is saying, what we can get from the global market is just the satellite bit of the portfolio, not the core.

Farley: The sterling market is 5 per cent of the global investment grade corporate universe. There are benefits to staying purely in sterling, you do not have any FX hedging, you do not have interest rate problems.

However, the global opportunity set is 95 per cent of the market. Can you find assets that you believe give greater diversification within a core portfolio and effectively pay for any costs on the hedging side?

Martinez: I agree with you, but for the smaller schemes who will do buy-in, the insurers are not going to take non-UK bonds, and if they do, you need to have done the hedging for them.

Heathcoat: I think schemes are thinking not just about what their strategy is now but how it develops over time. Done properly you have the right portfolio at the end but you do not miss out on opportunities en route.