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Credit: At the cliff edge

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An IPE snap poll suggests that even at the bottom of the nastiest bear market and the top of the longest bull market in history, portfolio positioning is far from simple. Martin Steward reports

Alongside our detailed case studies of the credit portfolios of Denmark's ATP and the Netherlands' APG, a quick survey of our pension fund readership during April 2011 gathered detailed responses from five institutions, whose assets under administration ranged from €20m to €5bn:

• One UK local authority pension funds
• Two UK corporate pension funds
• One Dutch corporate pension fund
• One Belgian corporate pension fund

Perhaps the most surprising finding of this (admittedly unscientific) survey was that one of the sizeable UK local authority pension funds that responded had no credit-spread product allocation at all in its portfolio before the 2008 financial crisis - and did not take advantage of the value opportunity of 2009, either.

Indeed, as figure 1 suggests, only one of these investors has increased its allocation significantly, and a couple appear to have been put off of credit, having been caught in the maelstrom of 2008 with sizeable allocations. It is salutary to be reminded that, for all the talk of ‘once in a lifetime' value in credit, the governance and decision-making structures at Europe's pension funds may have left many unable to exploit what was a very narrow window of opportunity.

Nonetheless, those investors who were able to move added exposures that would have been very difficult to find in a pension fund portfolio before the crisis - high yield, convertibles, local currency emerging market bonds.

Puzzle
Those investment decisions largely overlap with respondents' ideas about where value still lies, after two years of spread-tightening. But there are some interesting discrepancies, too.

Perhaps surprisingly, given the travails of the US dollar over the past year, these investors much prefer local to hard currency emerging markets: no doubt they are taking the longer view and picking up on a well-told story about the advantages of making a claim on the economic growth of the developing world through currency appreciation.
Elsewhere, it is interesting to note that, while one of our investors has made an allocation to loans, none regard it as a source of value at the moment. This is a puzzle: most fixed income specialists would observe that loans have lagged the general rebound in credit because of their floating-rate coupons - precisely the attribute that would make them most attractive among yielding assets once we begin to see the inevitable rise in interest rates.

But, as many pension fund investors have learned painfully over the past 18 months, there is ‘inevitable' - and then there is the timing of the inevitable.

That uncertainty comes through in responses to the question about what concerns investors most about their fixed income portfolios today. There is a consensus about the direction of the risk: "Duration risk," says one; "Yield," says another; "Inflation and the end of QE2," adds another; others fear a coincidence of rising rates and an equity market crash that leads to widening credit spreads, and the growing significance of "government risk". But as the manager of one of our UK corporate schemes warns: "[My concern is if] interest rates stay low and the duration of our fixed income [portfolio] is too short."

Indeed, in the week before this supplement went to press, the Bank of England kept its rate held at 0.5% as weak GDP growth and weakening inflation figures strengthened the doves' position, and the surprise announcement that the European Central Bank was not following its April hike with another in May - or giving any indication of the timing of the next hike - sent commodity markets and bond yields plunging.

It looks like we are set for yet another ‘interesting' year in the fixed income markets.
 

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