Asset owners — anticipating rising interest rates — are broadening their view of what they want fixed-income allocations to do.
Some are moving into more typical yield-seeking bonds, while others explore non-traditional investments that straddle the line between bonds and alternative investments.
It's not an easy move. Concerns about shifting from core and core-plus strategies center around predicting just when rates might increase, and risking the loss of downside protection with a move toward more esoteric investments in an asset class that historically has been staid and conservative.
“It's scary to make that kind of move,” said David Holmgren, chief investment officer of Hartford HealthCare, Hartford, Conn., which has $3 billion in pension, insurance and endowment assets. “What you're looking at in some cases is really just moving into a hedge fund.”
Still, many asset owners — particularly public pension funds, and endowments and foundations — have moved or are considering moves into fixed-income alternatives looking to gain the yields.
“It's as much art as science,” said William Atwood, executive director of the $14.5 billion Illinois State Board of Investment, Chicago, about fixed-income investing. “You have to get that 7½% rate of return.”
Corporate bonds still serve as a diversifier with negative correlation to equities, but “not as good as three years ago,” added Lee Partridge, chief investment officer at Salient Partners LP, Houston, and portfolio strategist for the $9.5 billion San Diego County Employees Retirement Association. On the credit side, “even though spreads aren't that bad, the returns are not what we'd like,” Mr. Partridge said, and the combination of those two factors “leads us to look for alternatives to fixed income.”
“This is happening, no question,” said Yariv Itah, managing partner at Casey, Quirk & Associates LLC, Darien, Conn. “Areas like loans and direct lending have the potential to see the greatest growth.”
Mr. Itah in May 2013 authored a white paper predicting $1 trillion will flow out of traditional fixed-income investments into more “next-generation” strategies through 2018. Although there are no more recent data, Mr. Itah said that anecdotally there's “a little faster shift” toward alternatives to fixed income than he originally expected. “A lot of money is waiting on the sidelines with full intention of moving ahead to do this,” Mr. Itah said.
However, the more esoteric and unique the alternative, the higher investors go on the risk spectrum.