“We see the current opportunities as being opportunistic because we don’t expect them to be there forever, yet in the long run we think credit is something that will almost certainly feature in most portfolios,” she says. “We see it as being a finite opportunity from a duration point of view.” One well-known super fund chief investment officer, who asked to remain anonymous, agrees opportunistic credit sits better within the growth part of the portfolio. “The practice of trying to enhance bond returns by including low grade credit is not a good one because in the past you’ve simply added equity-like risk to your bond portfolio.
In periods like this, you’ve seen what terrible harm that can do to your bond portfolio, which is meant to protect you against [market] downturn,” he says. “Credit risk doesn’t belong in a defensive portfolio – nothing but high grade credit belongs in a defensive portfolio.” However Daniel Vanden Boom, vice president at Morgan Stanley Investment Management, says for most clients, opportunities in credit markets still fit within their fixed income exposure. “There are some investors in Australia that believe there is the potential for better risk-adjusted returns from credit than equities or growth alternatives over the short to medium term and are thinking about making an allocation decision to take advantage of that.
There are other investors however that have traditionally within their fixed income portfolio always retained an exposure to the credit market and so a strategy that seeks opportunities within the credit markets would more naturally fit within their fixed income portfolio,” he says. “Now more than ever, it’s important to remember what clients’ overall objectives from fixed income portfolios are when analysing and pursuing credit opportunities.” Likewise the funding of opportunistic credit mandates varies from super fund to super fund, with some drawing from the cash stockpile they’ve built up over 2008, and others allocating away from equities and other growth assets.
Simon Doyle, head of fixed income and multi-asset at Schroders, says distressed securities with a higher degree of option premium associated with them should be funded from money that would otherwise be allocated to equities or alternatives. “Investment grade credit can form part of the defensive part of the portfolio, but as you start to step down the credit curve and move along the capital structure towards more equity-like risk – and high yield does have characteristics of equity market behaviour embedded within it – it should be funded from equities,” he says.