LOUISVILLE, Ky. - Looking for more alpha from their fixed-income portfolios, plan sponsors are starting to cast their eyes on high-yield securities.
Hiring activity among large defined benefit plan sponsors has picked up this year and is expected to increase dramatically in the next 12 to 18 months, according to the U.S. Institutional Market 2001 Trends Report issued by Mercer Manager Advisory Services, Louisville.
Mercer projects the number of high-yield placements will double in the next year as 4% of pension funds with more than $1 billion in assets plan to hire high-yield managers, up from 2% a year earlier. David Holmes, consultant with Mercer, projects 35 placements in the next year.
By comparison, Mercer tracked eight high-yield placements in the first six months of 2001 and 14 placements in 2000.
Mr. Holmes said declining interest rates and improved high-yield performance are leading plan sponsors back to the area. "Institutional investors are trying to get as much return out of the fixed-income space as possible," he said.
Year-to-date through July 31, the Salomon Smith Barney High Yield Bond index was up 5.2%. By comparison, the Salomon Broad Investment Grade index returned 6% for the same period. But for calendar 2000, the SSB High Yield index returned -5.7% to the BIG's 11.6%.
More plan sponsors also are viewing high yield as a separate asset class. In the past few years, the trend has been toward including high yield within a core-plus mandate, said Mr. Holmes. While core-plus searches are not projected to slow, he said, stand-alone high-yield activity is picking up.
Searches in progress
A number of large pension plans have high-yield searches in progress.
The $156 billion California Public Employees' Retirement System, Sacramento, is searching for three to five high-yield managers to run between $1 billion and $2 billion. With the move, CalPERS is doubling its exposure to high yield.
The $30 billion Massachusetts Pension Reserves Investment Management Board, Boston, is searching for a manager for a $600 million high-yield mandate. The pension fund had included high yield in its overall fixed-income portfolio, but the board decided to break it out into a separate asset class, said Stan Mavromates, senior investment officer. The board members did so as a result of an asset allocation study done earlier this year in which fixed income was reduced by four percentage points overall in the pension fund. No manager were terminated. "High yield is definitely a different animal than investment grade," and takes special skills to manage, he said.
The $3.4 billion Michigan Municipal Employees Retirement System, Lansing, recently created a separate high-yield allocation and hired Reams Asset Management, Columbus, Ind., to manage the $188 million mandate. Jeb Burns, director of investments, said fund officials created the allocation to get added diversification within the fixed-income portfolio.
Add some punch
Stephen Holmes, president of consultant Summit Strategies Group, St Louis, said investors are looking at high yield as an opportunity to add some punch to their portfolios. "High-yield bonds are looking a lot like small-cap value stocks did 18 months ago," he said, referring to the market swoon in March 2000. "If you're a contrarian by nature, you've got to love this asset class."
Then again, he added, it isn't the asset class that's going to make or break a portfolio. "But if you can squeeze an extra percentage point out of your fixed-income portfolio in an era of low returns, why not?"
Andy Kohnke, managing director at Hartford Investment Management Co., Hartford, Conn., said the equity market swoon has made plan sponsors look differently at their fixed-income portfolios. "In the past, plan sponsors looked at fixed income as the risk-averse part of their portfolio," he said. Now, plan sponsors are looking harder at their entire portfolio for returns. "Plan sponsors need to get that cash flow from somewhere. That's why they're looking at high yield."
Steve Nesbitt, senior managing director at Wilshire Associates Inc., Santa Monica, Calif., said spreads between high yield and investment-grade bonds have widened dramatically since late last year, making the market favorable for high-yield bonds.
Susan Small, head of consultant relations at Nicholas-Applegate Capital Management, San Diego, Calif., said there are clear differences between managing high-yield and investment-grade assets.
"High-yield bonds are driven by company fundamentals," she said. "Investment-grade bonds are driven by macro-economic policies."
She said the measurements traditional fixed-income managers use, such as duration, interest rates and convexity, don't work for high-yield portfolios. Rather, high-yield bond management places a premium on individual credit research and company fundamentals.
She believes plan sponsors should treat high-yield bonds as a separate asset class.
The Mercer 2001 Trends Report also found hiring activity will pick up in: active growth and value small-cap equity; active international equity; core-plus fixed income; and alternative investments.
Also, the report found hiring activity will decline in: active domestic growth; active midcap growth and value equity; active emerging markets; private debt; and active global equity and fixed income.