Institutional investors, grappling with low rates and tepid bonds in their safe-harbour portfolios, need to look further afield for better returns.
Canadian asset managers are increasingly turning to multi-asset credit (MAC) solutions to boost performance across a diverse global playing field, while becoming less dependent on safe, low-yield government bonds.
Two experts at PH&N Institutional recently shared their insights on MAC at an Association of Canadian Pension Management (ACPM) webinar hosted by RBC Investor & Treasury Services on February 10, 2022.
The Experts
Karen Kerr, CFA
Vice President and Institutional Portfolio Manager, PH&N Institutional
Jeff Roberts, CFA
Institutional Portfolio Manager, PH&N Institutional
1. Interest rates are rising, but harvesting sufficient returns remains a challenge.
Fixed income investors face significant challenges in locking down satisfactory yields—a problem that is expected to persist.
Monetary policy is still going to be accommodative when you look at it from a long-term historical perspective
“We have seen bond yields rise pretty dramatically, but we're still in a very low-interest rate environment," PH&N's Kerr told the webinar. She noted that, even with the recent rise in bond yields, approximately 17% of the global bond market carries a negative yield, while 79% is below 2%.1
“Monetary policy is still going to be accommodative when you look at it from a long-term historical perspective," she said, meaning that rates will remain relatively low to encourage growth.
2. Investors need bolder options.
Roberts said MAC is an effective way to unlock higher yields over the longer term, and it centres on exiting from traditional fixed income strategies. “MAC is a strategy based on a broad combination of different credit assets," Roberts said. This involves fixed income securities that carry credit and liquidity risk, unlike the low but safe returns from Canadian government bonds.
Although MAC has existed as a type of investment strategy since the 1990s, interest has soared with assets under management more than doubling to $225 billion over three years to the end of 2020.2
MAC is about “specifically looking for a strategy that targets a more attractive expected long-term return than some of those more traditional and conservative fixed income strategies," said Roberts. In addition, investment managers gain the flexibility to seek credit assets globally, and can jump on attractive opportunities as they arise.
3. Yields fall short when investors rely on the “usual suspects."
There are two mainstays in fixed income investing and both offer modest returns
There are two mainstays in fixed income investing. The Universe Bond Portfolio is made up of government and corporate bonds, and forward-looking models suggest a long-term expected annual return of 2.0%. Secondly, the Core Plus Bond Portfolio adds small allocations to higher-yield instruments such as emerging market bonds and commercial mortgages. Expected forward-looking returns are 2.8%, according to Roberts.3
Both options offer modest returns. “So, it really raises the question, what if you're still looking to efficiently target higher returns beyond what's on offer from these two usual suspects?" he asked.
4. Two MAC scenarios offer better yields—along with added complexity and risk.
To counter the low-yield problem, Roberts outlined two theoretical higher-return MAC portfolios. Both approaches eliminate government bonds from the asset mix to improve performance.
First, there is the Investment Grade MAC portfolio. It gives greater weight to emerging markets and high-yield bonds, producing an expected 3.6% return. Second is the Yield Maximizing MAC Portfolio, which targets high-quality, sub-investment-grade bonds. This portfolio produces an expected 5.1% return.3
Roberts said MAC brings more complexity and risk to a portfolio, and it's also "less constrained in nature." He adds, "Assessing a MAC strategy usually requires a reasonable level of experience and expertise in fixed income markets, which is often why we see MAC investors utilizing their relationships with trusted investment managers or investment consultants."
5. Managers can quickly adapt to global credit cycles.
MAC strategies look for opportunities across the globe, while taking advantage of the fact that interest rates and inflation vary from country to country. This offers enhanced strategies to manage risk.
MAC strategies look for opportunities across the globe
“These extra features really enable managers to quickly shift and reallocate risk within the strategies that they manage," said Roberts.
6. MAC works—as illustrated by the Sharpe ratio.
Roberts explained that the Sharpe ratio, a widely-used risk-adjusted return measurement, shows that the investor is rewarded for using MAC strategies. The ratio stood at 0.09% for the Universe Bond Portfolio and 0.25% for the Core Plus Bond Portfolio, but improved to 0.36% for the Investment Grade MAC portfolio and to 0.44% for the Yield Maximizing MAC portfolio.3
According to Roberts, the Sharpe ratio “really helps to provide evidence that, at each step along this path, we're not just seeing an increase in expected returns, but these strategies are doing so in an efficient manner." The investor is being “appropriately compensated" for taking a bolder position.