On the Record: How have you broadened your bond exposure?
Staffan Sevón - Head of fixed income and absolute return investments
• Location: Helsinki
• Assets: €35.8bn
• Members: 500,000
• Pension insurance company
Over the past years, we have had an uncharacteristically low duration in our fixed-income portfolio. At the end of last year we had a duration of around one whereas duration was as low as minus 1.8 at one point. This is essentially because the long-term expected return from taking duration risk is very low at current yield levels.
We have also increased the active portion of our portfolio, because you cannot rely on just the market return. Almost all of our fixed-income portfolio is managed in-house, including emerging market debt. We have a relatively low exposure to this asset class and perhaps it may be too early to jump back in, although certain segments of emerging market debt are starting to look interesting.
Opportunities in the high-yield sector are appearing, both in the US and in Europe but risks still remain. Higher-grade credit is also starting to look somewhat attractive. But, in general, the return offered by the market is very low compared with historical levels. This situation pushes us, not unlike many of our peers, towards ‘fringe’ fixed-income assets. We have have been running a portfolio of CLOs [collateralised loan obligations] in-house for a number of years with great success.
We are also invested in private lending. We believe these asset classes offer a good risk-reward profile, and are thus interesting both from a diversification and from a yield perspective. They are made particularly interesting by some of the structural trends in the economy. I believe Europe is undergoing the same structural change that has already happened in the US, moving from banking to other forms of lending for corporates.
I do not see Europe going back to a lending sector largely dominated only by banks. Banking regulation is stricter and banks have much less room for manoeuvre in terms of their balance sheets. They do not necessarily have a monopoly on the good deals, and are thus perhaps less competitive than before, even in higher-risk lending. However, when investing in alternative fixed income, it is particularly important to understand the market and to be selective.
Blanket investing in a selection of funds is not a good idea at all. For instance, in private lending the importance of deal flow is paramount. Understanding deal structures, leverage and the different jurisdictions is also fundamental. In general, you need to tread lightly in these markets.
Hans Copini - Head of fixed income
• Location: The Hague
• Assets: €115bn
• Members: 1m
• Fiduciary Manager
Our overall portfolio is split between a matching and a return portfolio. Euro government bonds, investment grade credit and Dutch mortgages are part of the matching portfolio, as well as the swap overlay portfolio. The matching portfolio amounts to roughly 50% of our total assets. Within the return portfolio, we invest in high yield (US and European) and emerging market debt (hard and local currency), which both amount to 7% of the return portfolio. Equities, real estate and alternatives are also part of the return portfolio.
Our liabilities are discounted against swap rates. Investing in government bonds means giving up yield compared to the corresponding swap rate. To make up for this negative swap spread, we invest in investment grade credit, which gives a higher yield.
Because the ultimate goal of the matching portfolio is matching the liabilities, there is a maximum amount we can invest in credits. We have also added mortgages to the matching portfolio, which gives an extra yield of 150 to 200 basis points over swap rates, and has a superior risk-return profile, in our view.
We would not characterise our approach to fixed income as active or passive. We favour an efficient implementation of beta, whereby we strive for transparency and reduced complexity, with a high awareness of cost. Within the defined products there is room to implement market views, but pure alpha generation is not our ultimate goal.
In our assessment of the global economic picture, we believe that the current loose policy of central banks will lead to a normalisation of growth and inflation, although at lower levels than before the credit crisis. This is being accompanied by periods of high volatility and a number of risk scenarios like Brexit, a hard landing in China and lower commodity prices. In this so-called ‘silverlocks’ scenario, risky assets will be supported but expected returns will be lower than they used to be. Interest rates will slowly rise, but we do not expect pre-crisis levels.
As our liabilities are our benchmark, the duration target is a given, so we do not need to change our duration in our portfolio. However, investing in a 30-year swap that yields 0.95% does not make much sense. Therefore, we have to look at other asset classes where we can profit from the illiquidity premium, such as mortgages and private loans. Investing in the Netherlands, through financing of SMEs, infrastructure or real estate is also high on the agenda.
Jørn Styczen - CIO
• Location: Copenhagen
• Assets: €12.1bn
• Members: active 208,000 / retired 53,000
• Guaranteed and non-guaranteed defined contribution (DC) plan provider
We made the decision, around two and a half years ago, to build a significant portfolio of senior secured loans. Our exposure to high-yield bonds and emerging market debt is relatively low. That has proved to be a very good strategy. During the first quarter of this year, the relative performance has declined, and this is linked to the fact that high-yield bonds and emerging market debt have made a comeback. But our view is that, at this stage of the credit cycle, it will pay us to stay at the top of capital structure, so we are going to keep our focus on senior secured loans.
The initial decision to invest in this asset class was based on the fact that senior secured loans were paying better yields than high-yield bonds at the time. That is because, even today, not so many institutional investors are able to access the asset class. Therefore, we saw some extra value in that area.
A large part of the European institutional sector is not able to invest in non-UCITS assets, which means that the market is not very crowded, as senior secured loans are non-UCITS assets. The US senior secured market is a lot more crowded, especially because mutual funds often allocate to the asset class. Therefore, at the moment we invest mainly in European loans, which has benefited us. We are slowly moving towards the US market. Spreads in US senior secured loans had a tough time in the second half of last year, so we are starting to see pockets of value develop in that market.
We work with external managers to access the senior secured loans market. It would be very difficult for us to access the market on our own.
We have a significant position in investment-grade credit but that is a really stable, large position. However, the main part of our fixed-income portfolio is invested in Danish mortgage bonds. This constitutes, along with positions in government bonds and derivatives, the part of our overall portfolio that we use to match our liabilities.
In the future, we believe private debt is going to be a major focus for us. In that market we see some similarities with senior secured loans, although the companies tend to be much smaller.
I take the view that the trend of bank disintermediation in corporate finance is a durable structural change in Europe. It is driven by regulation, and it is hard to see our economy moving back towards the previous bank-centred system.
Interviews conducted by Carlo Svaluto Moreolo