Mary McLaughlin, chief investment officer at Meat Industry Employees’ Superannuation Fund (MIESF), shares her insights with Investment Magazine on how in this difficult investment environment there are parallels between investors’ responses to asset allocation and to fixed income.
The problem facing investors at the diversified fund level is the same problem facing fixed income investors at the sector level; at both levels, funds are typically responding by choosing between three paths, not all discrete.
- The first is to accept that we are now in a lower return environment and focus on managing expectations and reinforcing the value of a long-term strategy, while at the same time trying to do what we do better: seeking further portfolio efficiencies and seeking additional opportunities within the strategic or sectoral asset mix. At the fixed income level, direct corporate lending is an example of a new opportunity that funds are exploring— newly available because of the post-GFC change in the activities of banks, and newly sought after as a source of yield. Commercial property debt and infrastructure debt also expand the fixed income opportunity set. Many funds are looking to capture these opportunities, either through internal teams or through external managers.
- The second approach that some funds are taking is to increase the risk of their portfolio: at an asset allocation (AA) level, this is by tilting towards higher prospective return asset classes; at a fixed income sector level, this is predominantly through an increased allocation to credit. It has been said that currently all diversified funds are one asset class riskier than they would really like to be — it may well be said that all fixed income portfolios are one dimension riskier than preferred, whether that dimension is duration, credit or liquidity.
- The third response is to hope that alpha can ramp up returns supposedly without ramping up risk. Funds are hoping that allowing managers to be unconstrained may generate new sources of alpha: at an AA level this has seen the popularity of Dynamic Asset Allocation and multi-asset funds. At the fixed income sector level, “absolute return investing” is the label being promoted by managers who claim that it was only being shackled to benchmarks that has stopped them delivering stellar outperformance. While it is beneficial for funds to not impose unnecessary restrictions on managers, funds and consultants are right to maintain some healthy scepticism about whether mandate constraints really restricted alpha generation. Questioning the quality of the risk budgeting by absolute return managers is also important; if there is little breadth in decision-making, the reliance on manager skill may be excessive and unrealistic.
Mary McLaughlin will be presenting at the Fixed Income, Cash and Currency Forum in Melbourne, July 26-27. To register for the event click here.