Dutch mature pension funds could improve their liquitity position by increasing their allocation to cashflow-generating corporate bonds, experts at the €775bn asset manager AXA Investment Managers have said.
Such a change in asset allocation – at the expense of equity and government bond holdings – would not significantly affect a pension fund’s returns, while contributing to its overall hedging strategy, according to Sebastian Proffit, head of portfolio solutions for fixed income.
During an online roundtable about liquidity and aimed at the Dutch pensions sector last week, he referred to Mercer’s last year’s European Asset Allocation Survey, which suggested that the percentage of defined benefit schemes in Europe with a negative cashflow is to rise from 60% to 90% in the coming 10 years.
The survey also indicated that 91% of the participating pension funds considered selling assets to improve liquidity which, Proffit said it “could be potentially risky as well as expensive”.
He said dealing with increased cash holdings and a new focus on divestment would require a different mindset at pension fund boards.
Chris Iggo, chief investment officer for core investments, also said that credit prospects are better than for equity, arguing that credit markets “have more support as well as potential for positive returns”.
“Most of the time, credit outperforms government bonds, with limited additional risk for the better quality of investment grade bonds,” he pointed out.
Iggo said he expected bond yields to stay low for the time being, with yields of 20-year Dutch government bonds remaining at zero at best.
The CIO said that, despite ample financial stimulus posed by the central bank’s buying and local governments issuing government bonds, there will be no upward pressure on interest rates for the near future.
He added that, after the initial fall of 33%, equity markets were unlikely to recover this year. “We expect equity to remain volatile, and I think that there is a significant risk of a second leg down,” he said.
Mohamed Maalej, head of portfolio engineering, said increasing a credit allocation to long-term dollar and sterling-denominated corporate bonds makes most sense, “as they usually have a longer duration than euro-denominated credit”.
However, both Iggo and Maleej higlighted the importance of research in order to find high quality credit.
Maalej also mentioned the recent 12% drop in credit markets in the past two weeks, whereas during the financial crisis the fall had amounted to 11% in total, spread out over a nine-month period.
He said ETFs had recently exchanged against discounts ranging from 5% to 20% relative to the underlying benchmark, leading to overall losses of up to 50% of their value.
Proffit said he had already noticed a lot of interest in cashflow-driven investment (CDI) in the UK, but noted it was too early to draw conclusions. He would expect the degree of CDI to gradually increase, as had happened with liability-driven investment (LDI).
He said that, based on their funding level which he estimated at 95% on average, UK pension funds could afford to de-risk through reducing their equity exposure in favour of credit and government bonds in order to decrease long-term liquidity risk.
According to Mercer’s survey, Dutch pension funds had a 16% exposure to credit as part of their bond holdings last year, relative to 37% for UK schemes.