Two of the largest institutional investors in Australia have revealed how they have developed concentrated high risk credit portfolios and built up large cash positions to cope with a low yield environment.

Speaking at Conexus Financial’s first annual Fixed Income Forum, James Waldron, manager debt and alternatives at the Future Fund, revealed how cash now stands at close to $20 billion, 18-19 per cent of the fund.

While Tim Peters, fixed income analyst at First State Super, told of how cash was now sitting at around 15 per cent of his fund’s $54 billion assets, some of this through synthetic exposures.

For Waldron the cash position had grown so high that the fund was looking to diversify away from local onshore banks, with some money now sitting with the RBA.

Waldron recognised that such a large defensive cash position would harm overall returns and that it was possible to go too far in de-risking the portfolio, but that the Future Fund’s long-term mandate enabled it such large shift’s in strategy

“The market is dictating this, but clearly there is going to be a limit to that. If we see another two years like we have just seen then you have got to have enough risk on to benefit from that.”

The counter balance to this large cash position has been for the Future Fund to make credit an “offensive” rather than a defensive asset said Waldron, with its managers having an “almost exclusively” total return approach.

“It needs to compete for capital alongside equities, property, infrastructure and other assets that have a risk adjusted return,” he said.

Waldron contrasted the current market where alpha can be generated from finding inefficiencies to the market of 5-6 years ago when returns could be made more easily from investment grade credit.

Now the Future Fund is finding its credit opportunities from situations where regulated investors are forced to sell off mortgages or structure credits due to rating restraints.

“There is still a pretty significant alpha opportunity that we see in credit given those inefficiencies and the way they manifest themselves through time,” he said. “That has been quite interesting for us.”

Tim Peters 400x200The Future Fund’s policy on credit managers is to give them “a lot of rope to move between sectors to take risk off themselves and move into cash as a risk mitigant given the way the fast way markets continue to evolve.”

Tim Peters of the First State Super too told of how his fund had moved from a “plain vanilla” fixed income portfolio over the last three years to become more active.

“Our skill set is to source managers to give us different parts of the credit spectrum and to consider how that fits together,” he said. “We need to give managers a real breadth and to move through the market.”

He was also looking for managers to be bolder about their best ideas for these to complement not only the rest of the First State Super credit portfolio, but the whole fund. “We have increasingly looked to managers to size-up credit opportunities,” he said, while acknowledging his fund was still on a journey to achieving the sophistication of the credit portfolio of the Future Fund.

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