MPS mines for income with alternative credit and shipping

Schemes are turning to alternative credit to maximise illiquidity premia and generate yields in a low interest rate environment, according to experts.

The MPS announced the allocation changes, which were funded by cash balances generated by previous equity sales, in its latest report and accounts.

It said: “Special situations debt will comprise a diversified portfolio of investments that capitalise from opportunities in niche segments of the debt and credit markets, including distressed debt.”

In the era of virtually zero interest rates they are prepared and they are looking at this illiquidity premia feature

Declan Canavan, JPMorgan Asset Management

“Shipping comprises a diversified portfolio of vessels looking to benefit from improved demand growth as global trade in consumer goods and commodities recover from current depressed levels.”

Stefan Dunatov, chief investment officer at Coal Pension Trustees Services Limited, said the scheme had seen greater opportunity for returns, “especially where those assets provided us with increased expected income flows, such as with private debt, property and shipping.”

The £10.5bn scheme planned to increase its allocations to the four asset classes over the year from September 2015, funded this time by outflows from cash and global credit.

Alternative credit

MPS, whose members’ benefits are guaranteed by the secretary of state for energy and climate change, focuses its investment strategy on providing bonuses for members above retail price index-linked benefit increases.

But Declan Canavan, EMEA head of alternative investment strategy at JPMorgan Asset Management, said illiquidity premia associated with alternative asset classes could prove attractive to a wide range of conventional schemes.

“In the era of virtually zero interest rates they are prepared and they are looking at this illiquidity premia feature.”

Alternative credit in particular has been highlighted as an alternative asset which provides an illiquidity premium, while also meeting the cash flow needs of pension schemes.

According to Canavan, pension fund investment in private debt has been further facilitated by tightening regulation around banks’ lending to businesses.

“The regulators have been very supportive of private capital... entering into this space to replace the sources of capital that are existing from the banks,” he said.

Distressed debt

MPS’s special situations allocation included buying distressed debt, a niche asset class that offers high returns, albeit with a stronger risk of the company defaulting.

Peter Thompson, trustee executive at Bestrustees, said high levels of governance and manager selection are essential to distressed debt strategies.

“In distressed debt what you need to be clear of is that what you are paying is no more than what you expect to get back,” he said. He added: “This is probably something for larger schemes because it needs more governance, it needs more specialist management, and management tends to be more expensive.”

Making waves in shipping

Allocations to shipping have also been predominantly the domain of a select few larger UK pension schemes like MPS.

“It isn’t an asset class that many institutional investors have invested in before, at least not directly,” said Gihan Ismail, business development director at shipping asset manager Marine Capital.

She insisted that volatile indices like the Baltic Dry Index, used to assess commodity transport costs, were not an accurate representation of the volatility levels of investing in shipping. She also said shipping could provide schemes with protection from wider market trends, and as a real asset class could provide attractive income.

“Shipping as a whole is quite lowly correlated with almost all of the other traditional asset classes,” she said. “Another reason is the growing interest in real assets,” she added. “So many institutional investors are now primarily focused on yield.”