Returning volatility could threaten illiquid fixed income holdings, experts say

World financial markets have rallied concurrently for the first time in 20 years, said Lisa Coleman, managing director and head of investment-grade credit at JPMorgan Asset Management, addressing delegates during the event on pension fund derisking last week.

It is very unlikely that any individual manager is absolute best-in-class in all of the underlying component pieces

Rawnak-Ul Islam

“What that says to me is, we’ve got an environment where everybody’s just trying to put money to work and [are] in search of assets, and that’s a challenge,” Coleman said.

But Chris Redmond, global head of bond manager research at consultancy Towers Watson, told delegates the transition towards less liquid assets in the search for yield contains an “inherent assumption” that investors are able to forecast what might happen throughout the investment horizon of those allocations.

“If we did see a return to volatility, those illiquid assets might be challenging,” Redmond said. “It’s interesting to think about whether that’s the right idea and whether the illiquidity that has been assumed is a good idea given that the absolute yield is quite low.”

He said the goal of defined benefit schemes’ endgame is to have a “fully immunised portfolio” that includes high-quality, interest rate-sensitive assets, but added: “The majority of clients aren’t there yet.”

And the paucity of such assets is pushing investors further out along the yield curve, or in extreme cases back into equities, he said.

The Pension Protection Fund, which has around 70 per cent of its portfolio invested in bonds and cash, revealed earlier this year that it will be reviewing its investment strategy to include additional illiquid assets and other forms of alternative credit. 

During the panel discussion, Rawnak-Ul Islam, portfolio manager for the PPF’s liability-hedging programme and tactical asset allocation, said the often private equity-like nature of such investments requires specialist managers for alternative credit.

“No single manager would have the skills to be able to provide the service,” Islam said. “You really need a specialist team that cannot be part of a global asset manager. They need to be more boutique-like. So it’s not so much the risk, it’s more [about whether] they have the skillset to produce alpha to the standard we require.”

Redmond said mandate designs were shifting back towards greater discretion for managers. But he warned there was a “material compromise” in multi-asset investing.

He said: “It is very unlikely that any individual manager is absolute best-in-class in all of the underlying component pieces. Furthermore, you are giving up significant flexibility around asset allocation.”