No money manager likes to leave return on the table, especially if it doesn't mean increasing the portfolio's risk level. But some managers handling pension fund assets may be doing just that, albeit inadvertently, according to new research from credit research firm MSCI Barra, Berkeley, Calif.
New data from MSCI Barra shows that the default probabilities between BBB-rated, or investment grade, and BB-rated, or sub investment grade, have converged dramatically over the last 12 months.
This convergence means that money managers can gain more return with a double-B rated bond without greatly increasing the risk of default. But managers with investment mandates that prevent them from holding bonds below triple-B — like many who run money for pension funds — can't capture that extra return, according to Tim Backshall, director of MSCI Barra's credit markets strategy group.
"There's unfair penalization of investment-grade managers not being able to pick up that extra return because investment mandates are ratings-driven," he said.
"But ratings are necessarily a lagging indicator. They could get a double-B return with a triple-B level of risk."
In early September, triple-B bonds had a default probability of 0.35% while double-B bonds had a default probability of 0.51%, according to MSCI Barra data.
"What these numbers are is a default forecast one year out," Mr. Backshall said. "They've converged and the break point between good and bad credit has drifted down. That barrier has broken to a lower level."