On the Record: What is your credit strategy?
What is your credit strategy?
• Invested assets: €1.2bn
• Members: 22,000
• Hybrid – DC but contributions are converted to pensions on a DB basis
• Solvency ratio: 105%
• Date established: 2006 (the original Construction Federation Operatives Pension Scheme was founded in 1965)
The pension scheme has eight member funds, which cover a lifestyling strategy from age 20 to 65, and one annuity or pensioner fund.
The annuity fund has an allocation to euro government bonds of 17%, while the members’ funds exposure to government and corporate credit amounts to 21% of the fund.
Each of the funds holds low-risk assets. But in the latter half of 2012 we decided that holding long bonds was only appropriate for members approaching retirement age insofar as those would match their pension liabilities. It was not an appropriate strategy for those up to the age of 55.
As a result, the funds with members under 55 years of age started to increasingly invest in short-term Gilts and corporate bonds with a duration of less than five years, while the funds with members over 55 are still in long bonds with a duration of more than 10 years.
We are not taking part in the great rotation from fixed income to equity – if anything, we are moving out of equities. We have strict minimum and maximum parameters for every asset class – that are unlikely to undergo another reshuffle any time soon – and we usually do not exceed the mid-point of the range set, unless there is strong bullish sentiment on, for example, equities. If equities exceed the mid-point on the back of market returns, we will sell them off to return them to the mid-range point.
There is still value in bonds, whether they are the government or corporate type, depending on what we use them for. But there is no doubt that spreads are going to go out soon.
We hold different bonds to fulfil specific needs. Some are part of a long-term strategy, and we let them run to maturity, while others are much more opportunistic and short-term in nature.
All the corporate bonds are European ex-financials and we invest in them through a segregated fund, as it was the only structure to exclude risky financials.
We have exposure to credit in the European periphery, albeit only in the members’ funds.
On the alternatives side, we have three separate GTAA, absolute return funds, which currently have €73m in investments. They all include a bond element but that is at the discretion of the respective fund managers.
The State Pension Fund (VER) Finland
• Invested assets: €16bn
• Members/insured: over 400,000
• DB buffer fund for the government and its employees
• Partially funded
• Date established: 1993 but in its current format since 2000
Currently we invest 17% of the overall portfolio and around 30% of the fixed income portfolio in corporate bonds.
Due to the challenging environment on the sovereign debt side, the exposure to credit has been steadily increasing since the financial crisis, although it has been stable of late.
Over the last five to six years we have also been expanding our investments in EMD. Both trends came at the expense of our sovereign allocation.
But as we remained stable in our 40% equity allocation it was merely a search for higher returns.
While the spreads have been narrowing, no strategic changes have yet been made with regard to credit. As long as this very low base yield continues, even that small spread is satisfactory. But we are aware that if sentiment turns, the liquidity is not going to be good in this asset class.
We have changed our EMD strategy from a diversified to a country-specific position over the last year. Our €1.5bn strategy is split equally between hard currencies and local currency investments.
Approximately €1.6bn of the €2.4bn invested in corporate credit is allocated to direct investment grade credit bonds in Europe, while the rest is invested in various mutual funds containing either pure investment credit or global high yield funds.
We are currently underweight corporate credit in the European periphery, especially in view of the possible ratings downgrade of the Spanish sovereign and related drop out of some heavyweight issuers from the investment grade index. Therefore, we do not invest according to the benchmark but are, to some extent, actively betting against it. We are also underweight the financial sector.
We also try to mitigate the duration risk in our credit portfolio by applying floating rate instruments. To some extent, the portfolio managers can also play the duration of the portfolio. Our large money-market exposure in the fixed income portfolio lowers the total duration of the portfolio too.
With regard to alternatives, initially mezzanine types of instruments were part of our strategy, followed by credit-orientated hedge funds.
This year, we created a new asset class – private credit – run by our alternatives team. Some of its credit instruments have been incorporated into that portfolio. We plan to expand that strategy.
Stichting Pensioenfonds Vopak, The Netherlands
• Invested DB assets €850m, DC assets €98m
• Funding level: 113% (market interest), 117% (UFR interest)
• Members: 1,317 active, 4,708 inactive
• Hybrid scheme with DB up to a salary of €51,745 and DC for the salary part above
• Date established: January 2002 (through the merger of three pension funds
Our allocation to credit currently makes up 35% of our overall portfolio and has been around this level since 2009.
Although the physical allocation may seem high, in terms of the allocation of risk, our exposure is more modest.
In benign environments, credits can generate useful returns, while in negative environments they usually incur less painful losses than equities. Just like equity risk premiums, credit risk premiums are supported by economic growth. However, their market dynamics are quite different, which leads to more diversification.
We deal with the risks from our credit investments through restrictions in our investment guidelines regarding credit ratings and total credit size per company. For example, 90% of our euro credit portfolio is restricted to investment grade bonds.
Filling in the portfolio is at our fiduciary manager’s discretion. They have included a limited number of credits in the European periphery. No sectors are excluded from selection into our credit portfolio as long as they remain within the realm of the relevant socially responsible investment (SRI) guidelines.
Our allocation to credit is also included in the interest rate hedge, whose effectiveness we measure on an on-going basis. At this time we still see value in credits. The volatility in equity returns has been high while credits have delivered more stable returns at a comparable level.
High rated government bonds, meanwhile, seem to be overvalued but remain a safe haven in distressed times.
We expect our allocation to credit to decrease in the future rather than to increase.
However, there are no specific plans to do so in the short term.
Apart from our credit exposure, our allocations to emerging market debt in both in local and hard currencies amount to 6.5% of our overall portfolio. US high yield makes up 2% of our total portfolio.
Investments in long government bonds such as Austria, Finland, France, Germany and the Netherlands together amount to 25% of our overall portfolio.
Credit strategies do not play a role in our alternative investment strategies.