GLOBAL - European pension funds that have adopted a 'wait and see' approach vis-à-vis the corporate bond market are likely to turn to BB investment grade or even high-yield bonds over the next 3-5 years, a Swiss asset manager has predicted.

According to Mirko Santucci, head of credit at Swisscanto, Swiss pension funds and their counterparts across Europe are currently sitting on large piles of cash in their portfolios - some with more than 10% - as a means of protecting themselves against another potential market fall.

Santucci told IPE: "Pension schemes are particularly cautious at the moment given the current market turbulence. As a result, we have seen marginal inflows in investment grades, but large outflows in high yields."

However, the situation is likely to change over the next 3-5 years, as the market is expected to remain far below its growth potential, according to Santucci.

"Possibly, the best investment would go in the investment-grade BB area because, on the one side, pension funds can hold out in terms of prices," he said.

"On the other side, they are not very much dependant in terms of duration at the moment. But, in the next three years, duration will start playing a more important role - at least over the short term - than is currently the case."

In addition, Santucci expects European pension funds to focus more on absolute returns in the coming years, while some of them use either high-yield bonds or equities as the best hedge against inflation.

As part of its strategy, Swisscanto is currently seeking to buy mispriced debt as a means of getting a larger spread on the bond.

"To give one example," Santucci said, "Tesco was discussing an issuance of a five-year corporate bond at LIBOR+150 earlier this week. Given the fact Tesco is rated A-, the company should trade at LIBOR+50 throughout the cycle, which means you can get three times the spread."

Santucci predicted the US corporate bond market would continue business as usual in the first quarter of 2012, while the European market will be likely to suffer due to political instability.

"If political issues are solved, we will see a lot of issuance from banks on the corporate bond market, as they will have to fund themselves throughout 2012," he said.

"If not, the market will remain sluggish, as banks are currently seeking to clean up their balance sheets by reducing their risk-weighted assets and are not willing to take on additional risk."