Alternatives to traditional fixed-income allocations take different shapes based on the different roles fixed-income investments play in asset owners' investment portfolios.
Three asset owners — two pension systems and an endowment — are using different asset classes and allocations to get fixed income-like investment results, based on their philosophies about what fixed income provides for them.
At the $25.4 billion Employees Retirement System of Texas, Austin, its 30% fixed-income allocation is divided among suballocations of rate-based, credit-based and transition investments — temporary investments used to shift between the other two suballocations, said Leighton Shantz, director of fixed income. However, the system's most recent asset allocation, adopted in February 2013, includes its 10% target on credit-based investments within its overall 79% allocation to return-seeking assets, while the 15% target to rates-based investments is part of its 21% risk reduction and liquidity assets allocation. The pension fund will reduce its overall fixed-income allocation to 25% in 2015; its current allocation is 30%.
“We had core-and core-plus-based, traditional allocations to fixed income ... we thought it made more sense to bifurcate fixed income into two distinct asset classes based on our needs,” Mr. Shantz said. “Looking at our actuarial needs, we figured out pretty quickly that we would need to monetize our assets. I found it better to counterallocate, hoarding our liquidity in one book. Coupon and maturities should come out at 8%, which is what we need.”
Through this overall strategy, the pension fund can meet its liquidity needs while not cashing out any return-seeking investments. “We're benchmarked against the underlying assets, but trusts like ours get into trouble when they monetize assets at a loss,” Mr. Shantz said. “We want to strategically position the portfolio in the other direction so that all our liquidity needs are met.”
Texas Employees' credit portfolio includes emerging markets and high-yield debt, leveraged loans and asset-backed securities; its benchmark is the Barclays Capital High Yield bond index plus 2 percentage points. The rates benchmark is the Barclays Capital U.S. Intermediate Treasury index; its transition portfolio is benchmarked to Barclays Capital U.S. Intermediate Credit Bond index.
The Barclays Capital Aggregate index — long the standard in core and core-plus fixed income strategies — “no longer has any relevance to us,” said Mr. Shantz.
The transition portfolio has gone from $3 billion to $600 million in a year. “We liquidated as fast as we could,” he said. “We wanted to get it done.”