Survey: Schemes get more sophisticated on fixed income

There have been two great shifts in pension scheme attitudes to fixed income over the past three years, according to a schemeXpert.com and Pensions Week survey of leading scheme managers and trustees.

Not only have they become more cautious, circumspect or simply picky about the asset class, but they have also become more sophisticated. 

Greater caution

The greatest concern among these schemes, representing a total of £128bn, is that their fixed-income holdings do not appear as good value as they were in 2008 – particularly in relation to equities.

“In 2008, bonds appeared like a safe haven given the turmoil in equity markets,” said one scheme manager. “We have experienced a long period of extraordinary low interest rates, but are now concerned that rates must rise at some point and the value of our fixed-income holdings will fall.

“The schemes are not yet locked into a liability-matching strategy because of the current low yields. However, index-linked bonds do look appealing given the inflation outlook.”

Schemes are also queuing up to express their growing fears of inflation and interest rate risk. “We’ve sold our fixed-interest gilts and purchased index-linked gilts,” said one.

Others spoke of now only holding gilts that were index linked, while one spoke of a greater need for inflation-linked products, particularly CPI-linked bonds.

There were comments about experiences of unexpected volatility and concern at the valuation of government bonds, which one manager summed up as idiosyncratic.

Another, perhaps sarcastically, told of gaining an improved “view” of the reliability or low risk associated with corporate bonds. One stated they had “greater awareness of the correlation between corporate debt and equity when finances are squeezed”.

Similarly another said: “We have better appreciated the asset class’s risk/return profile.”

And one summed it up as being “broadly more risky and more expensive than in 2008”.

Becoming more sophisticated

The past three years have seen a range of strategies employed for the first time. These range from the simplest – using gilts to match specific scheme liabilities or as a way to reduce volatility – to the following ingenious ploys.

A multi-billion pound fund stated it had “increased the use of liability-driven investment (LDI) in the fixed-income space, with segregated mandates allowing flexiblity as to which discrete classes to use”.

Most of its exposure was in a global mandate made up largely of credit, with a significant use of derivatives and asset swaps. 

The ingenuity of others knows no bounds. One scheme has recently overcome the relative high price of bonds by turning to cheaper assets with similar cash flows, such as high-income UK equity and long-lease property.

Another strategy was explained as follows: “[We] moved to a combination of an active policy for creating the initial criteria/parameters for investment to achieve a form of cash flow matching, and a passive policy for actual management to those parameters.”

Some have moved in the opposite direction to the crowd.

“We have had an approximate 45% exposure to fixed interest for a number of years, and mid-2008 we linked this to duration-matching,” stated one.

“We unwound this position in December 2010 and now have no direct exposure to fixed income, but as we use Standard Life’s GARS Fund, we will have some positions within this.”

Elsewhere there has been a move to more active strategies in the past three years. Some put this down to the rise in opportunities and to the greater range of funds – particularly absolute return funds. Corporate bonds have tended to be the beneficiary of this at the expense of gilts.

No change or greater interest?

As one might expect, the shift to fixed income has been driven by derisking – some citing moves as little as 10% to 15%, though a move from 30% to 50% has been typical.

The most extreme was a scheme that moved from a 10% to a 44% fixed income allocation within this timeframe, largely as the scheme had achieved full funding, making the move affordable.

The move, though, has not always been as simple as hoped.

“We have derisked significantly towards gilts, perhaps against our normal commercial instincts,” said one scheme, while another said: “It has grown but not to the extent that is perhaps desired because of the funding shortfalls in the schemes.”