Feature


the past. Investors will need to learn to navigate an era of low re- turns and elevated volatility.” Chetan Ghosh, chief investment officer of the Centrica Pension Schemes, says that in the current environment bond investing should be seen as a long-term strategy. “Low prevailing bond yields mathematically cap the prospective short to medium-term returns available from fixed income and invariably returns from this asset class will likely be low in that time frame. “The position for UK pension schemes that are well hedged is a bit more nuanced,” Ghosh adds. “The hedging changes the purpose of fixed income assets in the portfolio. Rather than using fixed income to deliver high total return, the investment problem becomes more focused on successful credit spread capture over time. Investors can still seemingly harvest reasonable excess returns from credit spreads at current prices.”


On another measure, in a rising interest rate environment fixed- rate bonds become cheaper, and, therefore, may be more attractive assets to hold. “In addition, variable rate bonds in the form of structured credit products are going to benefit from rising rates as their coupons rise,” Hedges says.


Hedging risks


Analysing the picture further, as gilt yields/bond prices impact pension schemes on the asset and liability side, what should pen- sion funds keep central to their thinking? Hedges offers a succinct outline. “Pension funds face four risks that they don’t get rewarded for, three of them impact the liabili- ties: interest rates, inflation and longevity; the fourth is sponsor risk,” he says. “So, hedge the risks and then focus on investments to make returns to drive funding


towards the long-term


objective.” Ghosh adds that investors should understand why they are buying bonds. “It is really important to get clarity of purpose for why fixed income assets are being held,” he says. “For example, highly hedged schemes may be happy to harvest spreads from potentially low return fixed income assets under a cashflow driven invest- ment framework and not be unduly worried about rising govern- ment bond yields.”


Shaw notes there are niche classes within fixed income that still offer value – particularly short-term loans offering high yields. “By short term I mean six months to maybe 18 months and by high yield I mean several times what most traditional fixed income debt is paying.


“There are non-mainstream asset classes out there which can pro- vide good yields and while traditionally these non-mainstream assets – such as P2P loans and private debt – have formed a very small proportion of assets, maybe the time has come to change that balance,” he adds.


Income stream 20 May 2021 portfolio institutional roundtable: Fixed income


For a pension fund, much of the holdings of gilts and linkers aren’t bought for their investment returns, they are primarily about


managing the liability risks. Mark Hedges, Nationwide Pension Fund


It is therefore an environment in which many subtle factors are at play, so Hedges believes that pension funds should stick to what they know. “Pension funds’ primary obligation is the payment of pensions to their beneficiaries. Fixed income will generate an income stream and notwithstanding a change in the bond’s value, the cashflow in terms of coupon payments remains unchanged, so changes in the interest environment don’t necessary change the cash that a fund is going to receive.” Although Christopher Teschmacher, fund manager at LGIM, says that the traditional view of bonds is being challenged. “The efficacy of bonds as a safe-haven asset class in risk-off periods is now heavily compromised,” he says. “Indeed, recent months have shown an increasingly worrying pattern of bond yields rising on days when equities are falling, rather than the other way round. Holding duration in your portfolio hasn’t helped when you need it most.” Shaw offers an alternative to fixed income for those concerned about yields. “It’s time to look at alternative assets,” he says. “But do spread your net widely and don’t invest too much in each alter- native investment – try to get a basket of investments, and in that basked don’t stick to one provider but invest in a variety to reduce your risk profile.” Ghosh urgers caution here. “Alternatives to fixed income come with likely higher risk implications,” he says. “Pension funds need to evaluate if the purpose of fixed income is for driving high total returns or spread capture.


“If the ambition is high total return, then other options that allow


Page 1  |  Page 2  |  Page 3  |  Page 4  |  Page 5  |  Page 6  |  Page 7  |  Page 8  |  Page 9  |  Page 10  |  Page 11  |  Page 12  |  Page 13  |  Page 14  |  Page 15  |  Page 16  |  Page 17  |  Page 18  |  Page 19  |  Page 20  |  Page 21  |  Page 22  |  Page 23  |  Page 24