For some asset owners, getting more yield out of fixed income means letting go.
Unconstrained strategies have the flexibility to shift tactically from traditional fixed income into bond alternative strategies, but it's often a difficult sell to investment executives at pension funds, endowments and foundations who are used to working with a benchmark.
“Pension funds are wary about unconstrained strategies, because of the inability to hedge or model the portfolios like you can with traditional fixed income,” said Don Plotsky, head of the product group, Western Asset Management Co., Pasadena, Calif. “Still, there are a lot of pension funds thinking unconstrained. Ultimately it's a decision between the client making the asset allocation vs. the manager making the asset allocation.”
The $14.5 billion Illinois State Board of Investment, Chicago, had invested in “deconstrained, core plus mandates” in the early 2000s, said William Atwood, executive director. “Since that time we have allocated to discrete, defined strategies — the drivers being primarily to better identify and monitor investor skill and to retain greater control over portfolio construction, asset allocation, and risk.”
Added Mr. Plotsky: “The biggest issue is the flows away from investments with a traditional benchmark like the Barclays Agg (Barclays Capital Aggregate Bond index) to unconstrained fixed income. Low yield and high duration is not where you want to be today.”
Another concern for investors is what exactly they will be getting into if they go into unconstrained fixed income, which Steve Center of Callan Associates called “a whole different beast” compared to core bonds.
“Are they fixed income or are they alternatives? A lot of strategies are less fixed income and more alternatives,” said Mr. Center, vice president, global manager group, fixed income, at Callan in San Francisco. “We've stressed overall to our clients to ask themselves why they have fixed income in the first place. Is it a return-seeking asset or a diversifier of risk? A lot of investors are forgetting the drivers of a fixed-income portfolio, the benefits of having fixed income in their portfolio.”