When bond portfolios – the traditional defence for institutional investors – were smashed during the financial crisis, managers worldwide rushed to buy US government debt. This showed how far many had ventured beyond sovereign markets in their aim to outperform global aggregate fixed-income benchmarks – the catch-all indices for credit markets. Now, to better control the risks in their bond portfolios, some institutions are dictating which types of markets each of their bond managers can invest in, effectively disaggregating their credit exposures. SIMON MUMME reports.

MLC’s $12.5 billion global bond portfolio was performing well up until the collapse of Lehman Brothers, after which “things started to shake and rattle pretty hard,” says Natalie Comino, senior investment specialist, who works closely with Stuart Piper, who runs the manager’s debt strategies. Looking inside the portfolio, they found managers were doing exactly what they were paid to do: take active positions in global credit markets. But in aggregate, they amounted to concentrations of risk that were too much for MLC. “They could see great value in some sectors, and that’s great, but at a portfolio level we had no way of controlling the risk that clients wanted,” Comino says.

This was a problem for many institutions whose managers were competing against global aggregate bond indices, which include an array of debt markets, from sovereign bonds to securitised mortgages. These ‘global agg’ indices carry a lot of yield, compelling managers to take on more risk in their pursuit of outperformance. This worked well: until the market crashed and investors turned to their bond portfolios for all-weather returns. MLC was among them. Now it has restructured its Horizon bond portfolios so not all its managers are given free rein to invest in all sectors of global aggregate indices. This disaggregation of risk is what institutions applied to equity portfolios some years ago, when allocations were made to, among others, value, growth, small-cap and emerging markets managers.

Managers in the Horizon portfolios have been given more specific mandates, including domestic bonds, global government bonds, global absolute return bonds and global mortgages. But MLC retained an exposure to global multi-sector managers, who shift capital around global markets. “It’s a better way of taking control, so we can make big-picture decisions, although we don’t expect these to be frequent,” Comino says. “At certain points in the cycle, like in the period leading up to subprime when risk wasn’t being rewarded – why would you bet there?” MLC also applies a strategic overlay to each of the Horizon funds, which allows it to react more quickly to trends in bond markets and tilt exposures by up to +/- 5 per cent. “We don’t take the big decisions in the Horizon portfolios. It’s just tweaking.”

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