Previously inaccessible alternative credit markets are now available to portfolio managers with a range of risks, geographies and products, fixed income and cash specialists have said.
From high-yielding bank loans in Europe, the US and Australia to private lending, asset-backed real estate and emerging markets in hard currency, and sovereign and corporate bonds – the options are growing.
Willis Towers Watson head of credit Simon James, who defines alternative credit as all non-traditional, non-government lending, said the evolving and dynamic asset class required specialist skills to manage. Asset owners needed to be opportunistic to deploy capital optimally in this asset class, he said in a panel discussion at the Investment Magazine Fixed Income and Credit Forum held in Victoria last week.
“Our preference is for specialist managers, particularly as you go into more complex strategies, these require specialist skill sets,” James said. “My advice is to use the breadth of opportunities to your advantage to build a portfolio of alternative credit. Take your liquidity when you’re paid to do so, embrace the complexity when your governance framework permits, and the high yield that comes with it, and diversify away from corporate credit, geography and credit type” he said.
While it was late in the corporate credit cycle, credit portfolio managers could tilt towards the household and consumer balance sheet, particularly in the US, he said.
James expected Willis Towers Watson should be sitting at a 5-10 per cent allocation to alternative credit strategies in five years.
Sunsuper fixed income and cash investment manager Jason Huang said the fund invested in agency mortgage-backed securities and had a securitised credit strategy in its fixed income program.
Higher quality asset-backed lending gave defensive characteristics while returns from securitised credit markets were not.
“You need to look at the manager’s skill to really dive into these structures as well as the structures themselves,” Huang said.
Victorian Funds Management Corporation (VFMC) senior portfolio manager Adam Scully said returns could be a “broad church”, from mid-single digits for vanilla direct lending strategies to high teens for specialist private equity and distressed debt strategies.
“It’s about making sure that wherever you sit on that spectrum you’re being properly rewarded,” Scully said. “From a return comparable point of view, there’s not one necessary comparison that fits all. For a direct lending strategy your appropriate comparable would be debt capital markets and hopefully your getting some extra return for the illiquidity and maybe managing the complexity.
“As you move up the spectrum to a distressed situation strategy, I think private equity is an appropriate comparable…and you have a maturity date as an exit mechanism for your investment and you get similar-type returns then I think it compares pretty well.”
He does not see alternative credit as a fixed income substitute.
“They’re more potentially a growth asset substitute sitting within the absolute return portion of your portfolio,” he said. “They’re not designed to be defensive so if you’re lumping them in with defensive you’re going to get a mismatch at some point in the cycle.”