Crunch time for credit investors

For over a decade, the low-yield environment has forced asset allocators to reassess traditional fixed income allocations. Today’s new era of higher inflation, rising rates and increased macro/geopolitical uncertainty brings a greater sense of urgency to the task. To meet their members’ investment needs, DC schemes need to embrace a dynamic, active and sustainable approach to managing their fixed income exposure across the glide path.

11 Jul 2022

3 minutes

Jeff Boswell
For over a decade, the low-yield environment has forced asset allocators to reassess traditional fixed income allocations. Today’s new era of higher inflation, rising rates and increased macro/geopolitical uncertainty brings a greater sense of urgency to the task. To meet their members’ investment needs, DC schemes need to embrace a dynamic, active and sustainable approach to managing their fixed income exposure across the glide path.

So far this year, fixed income investors have faced a double whammy of rising yields and widening credit spreads. Monetary policy is a key driver of this shift: most central banks have begun to increase interest rates to tackle inflation and are retreating from bond markets, having been major buyers in recent years. War in Ukraine has further weighed on risk appetite and increased inflationary pressures.

The environment of ongoing inflationary pressure and challenging forward-looking returns means members need to make use of the broadest possible opportunity set to generate returns through to retirement. In this context, an unconstrained credit strategy can play a valuable, diversifying role in a DC growth portfolio. Furthermore, as the age profile of DC members matures, successfully managing drawdowns is crucial for making portfolios downside aware in their growth phase. When compared with static allocations to traditional fixed income, unconstrained credit strategies (which can be truly dynamic) seek to offer members a smoother path of returns through to retirement.

An unconstrained credit strategy, in which the manager has multiple levers to pull in search of attractive, bottom-up ideas in all market environments, can provide an effective solution for DC members who are looking to:

  • Diversify their existing portfolio, which has a passive equity bias and is underweight credit
  • Implement a flexible building block through an all-weather credit portfolio
  • Add yield to the portfolio in a risk-controlled manner, while also outsourcing difficult asset allocation decisions within fixed income
  • Access a broad fixed income opportunity set - including specialist asset classes, which are difficult to access individually

To address some of these challenges, Ninety One brings something different to the DC table, with a range of actively managed, sustainable DC solutions. Among these, our Global Total Return Credit (GTRC) strategy is used by DC members as a key building block of their growth portfolio. We offer members access to the best ideas available across a broad universe of credit markets, without taking duration or currency risk. We seek to be defensive in downturns and to capture upside consistently through the market cycle, resulting in a smoother path of returns for members. GTRC can be an important, actively managed diversifier of returns within growth portfolios that are dominated by passive equities and traditional investment-grade fixed income.

In the past few months, our GTRC approach has seen us rotate into higher-quality market segments that had underperformed until recently. Using our full investment universe, we have also allocated to defensive investments such as short-duration credit. We think these areas offer a good balance of potential upside if markets improve and downside protection should volatility remain high – an important balance when pursuing a smooth path of returns.

The long-term time horizons of a DC scheme member and sustainability considerations are intrinsically linked. A young DC member today will almost certainly witness the global energy transition in their lifetime, creating new risks and opportunities to navigate in their retirement portfolio. To combat this, our Credit team has developed a proprietary sustainability framework, including a forward-looking Transition Alignment evaluation, which assesses transition risk for all holdings.

To summarise, we believe a reassessment of fixed income allocations within DC portfolio is needed. In the era of rising inflation, challenging forward-looking returns and an urgent energy transition, DC members should embrace a dynamic, active and sustainable approach to managing their fixed income exposure.

Specific risks

Default: There is a risk that the issuers of fixed income investments (e.g. bonds) may not be able to meet interest payments nor repay the money they have borrowed. The worse the credit quality of the issuer, the greater the risk of default and therefore investment loss. Derivatives: The use of derivatives may increase overall risk by magnifying the effect of both gains and losses leading to large changes in value and potentially large financial loss. A counterparty to a derivative transaction may fail to meet its obligations which may also lead to a financial loss. Interest rate: The value of fixed income investments (e.g. bonds) tends to decrease when interest rates rise. Liquidity: There may be insufficient buyers or sellers of particular investments giving rise to delays in trading and being able to make settlements, and/or large fluctuations in value. This may lead to larger financial losses than might be anticipated. Emerging market (inc. China): These markets carry a higher risk of financial loss than more developed markets as they may have less developed legal, political, economic or other systems. Income Allocation: On some investments (e.g. the Implied Yield from Forward Foreign Exchange derivative contracts) any gains may be allocated to income rather than the capital account. This may cause greater fluctuations in the capital value of the fund. Income may be taxable.

General risks

All investments carry the risk of capital loss. The value of investments, and any income generated from them, can fall as well as rise and will be affected by changes in interest rates, currency fluctuations, general market conditions and other political, social and economic developments, as well as by specific matters relating to the assets in which the investment strategy invests. If any currency differs from the investor’s home currency, returns may increase or decrease as a result of currency fluctuations. Past performance is not a reliable indicator of future results. Environmental, social or governance related risk events or factors, if they occur, could cause a negative impact on the value of investments.

Authored by

Jeff Boswell
Portfolio Manager

Important Information

This communication is provided for general information only should not be construed as advice.

All the information in is believed to be reliable but may be inaccurate or incomplete. The views are those of the contributor at the time of publication and do not necessary reflect those of Ninety One.

Any opinions stated are honestly held but are not guaranteed and should not be relied upon.

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