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Special report: Fixed income

More seek multiasset credit strategies to diversify return stream

James E. Keenan said pension funds are trying many different things to keep liabilities manageable.

Updated with correction

Faced with an expansive, complex array of credit investment options and an urgent need to incorporate them into their portfolios as a way to drive returns, asset owners increasingly are turning to multiasset credit strategies.

Managers of MAC strategies, also called multisector fixed-income funds, report high interest and strong inflows into portfolios, which invest across a wide spectrum, from liquid, publicly traded investment-grade and high-yield bonds to illiquid private credit instruments such as securitized strategies, middle-market lending and specialty financing to industries including aviation and entertainment.

"Interest in multiasset credit portfolios has picked up materially in the last six to nine months as investors seek to diversify return sources and manage drawdown risk," said Maura T. Murphy, vice president and co-portfolio manager at fixed-income specialist Loomis Sayles & Co. LP, Boston.

Loomis Sayles managed a total of $268.1 billion as of Dec. 31, of which $5.7 billion was in multiasset credit strategies.

Recent investors in multiasset credit funds include:

Florida State Board of Administration, Tallahassee, which committed $200 million from the $167 billion Florida Retirement System to DoubleLine Opportunistic Income Master Fund, managed by DoubleLine Capital LP; St. Louis Public School Retirement System, which committed $35 million from the $866 million fund to Neuberger Berman Investment Advisers LLC's Global Opportunistic Fixed Income Fund; the $3.8 billion San Mateo Employees' Retirement Association, Redwood City, Calif., which committed $80 million to PIMCO Diversified Income Fund, managed by Pacific Investment Management Co. LLC; and the $312 million Hollywood (Fla.) Employees' Retirement System and the $340 million Boca Raton (Fla.) Police & Firefighters Retirement System, both of which made commitments of $12 million and $17 million, respectively, to GoldenTree MultiSector fund, managed by GoldenTree Asset Management LP.

'Thinking differently'

To match pension fund liabilities in what is expected to be a low-return environment, institutional investors are "thinking differently, turning to different tools and different assets" to increase returns, said James E. Keenan, chief investment officer and global co-head of credit at BlackRock (BLK) Inc. (BLK), New York. "Everyone is out there looking for a way to increase returns" and the new assets they are turning to are found in the private credit segment of the market, Mr. Keenan said.

BlackRock managed $6.3 trillion as of Dec. 31, $1.9 trillion of which was in fixed income. Mr. Keenan oversees $82 billion in credit investments. BlackRock does not break out assets managed in multiasset credit strategies.

Napier Park Global Capital LP, New York, has attracted $10 billion to its credit strategies in the five years since the firm's launch in 2013, including $4 billion in MAC investments, said James M. O'Brien, senior managing partner and CEO.

Napier Park invests exclusively in what Mr. O'Brien labeled specialized credit — highly complex, illiquid credit niches including aircraft and railcar leasing, collateralized loan obligations and specialty lending in the form of directly originated mortgage and consumer loans among other instruments.

Napier Park is seeing more interest in and demand for its MAC strategy this year, Mr. O'Brien said, noting that the firm's investment structure "allows us to dynamically allocate capital where there's value."

Among recent commitments to the Napier Park MAC approach is a $180 million allocation from a Taft-Hartley pension plan for a diversified credit allocation. Mr. O'Brien said he could not identify the investor.

Sources said MAC strategies emerged at the beginning of the decade when it became clear to some investors that unconstrained bond approaches had failed to diversify traditional bond portfolios and improve returns.

"Performance of unconstrained bond funds has not lived up to expectations. The scenarios managers were counting on clearly didn't come to pass," said Kevin D. Machiz, vice president and fixed income-consultant in San Francisco-based Callan Inc.'s global manager research group.

MAC strategies have evolved from the early days, when the furthest that managers dipped down the credit complexity scale was to corporate high-yield bonds, leveraged loans and collateralized debt obligations, said Thierry Adant, credit research consultant in the New York office of investment consultant Willis Towers Watson PLC.

Many MAC strategies now incorporate complex, illiquid securitized products, multiple forms of distressed debt and esoteric financing strategies.

By adding exposure to a much wider universe of credit instruments that are actively managed, Callan's Mr. Machiz said "there's more potential for outperformance," adding that analysis shows active fixed-income managers outperform passive approaches on a historical basis and are less correlated to each other.

Creating and managing a private credit portfolio can be problematic for institutional investors, particularly smaller, less well-resourced pension funds, observers said.

"The private credit universe has many illiquid niches and its complexity creates barriers to investment for institutional investors," Willis Towers Watson's Mr. Adant said.

Constantly raised issues

Tactical asset allocation and dynamic management of credit portfolios are issues constantly raised by institutional CIOs across the U.S., Asia and Australia in conversations about MAC strategies, said Matthew Toms, senior vice president and chief investment officer-fixed income, Voya Investment Management LLC, Atlanta.

"There's real frustration about lost investment opportunities" for many pension executives because the governance structure of their pension fund inhibits their ability to respond quickly enough to commit to private credit deals or rebalance credit portfolios, Mr. Toms said.

"The question for pension funds is whether they should complement what they have now in fixed income with individual strategies or invest in a single diversified strategy," Mr. Toms said.

Voya managed a total of $222 billion as of Sept. 30, of which $151 billion was in fixed income. Voya does not break out the assets managed in multiasset credit strategies.

BlackRock (BLK)'s Mr. Keenan said building and maintaining a 25-manager private credit portfolio is "difficult, expensive and takes a lot of time" and stressed that rebalancing and appropriately weighting allocations to the managers in the portfolios is the most difficult — and important — part of the investment process.

"Multiasset credit portfolios need dynamic rebalancing to capture the return dispersion between geographic areas and sectors. It's hard to do that if you're invested with multiple managers," Mr. Keenan said, adding that rebalancing is an integral function of multiasset credit strategies.

Big credit managers like BlackRock notwithstanding, "credit grew up in boutiques," said a source who preferred anonymity, who noted that the expertise and experience of smaller specialist managers bring to private credit investing remains in high demand by institutional investors.

In fact, institutional investors were the impetus behind the addition of multiasset credit strategies by many boutique managers, sources said.

Stone Harbor Investment Partners LP, New York, for example, created its multiasset credit approach in 2011 after a request from consultants and prospective clients for a strategy to help them achieve fixed-income returns between 6% and 7%, said David A. Torchia, portfolio manager-multisector strategies.

Stone Harbor takes a top-down approach to determine the asset allocation and relies on the bottom-up investment decisions of its specialist strategy for security selection, Mr. Torchia said. "Multiasset credit is our team sport," he added.

The strategy is liquid, relying on a mixture of traditional fixed-income securities, global high-yield bonds, bank loans, and emerging markets sovereign debt in hard and local currency. In managing the portfolios, Mr. Torchia used exchange-traded interest rate futures to manage duration and yield curve; index credit derivatives to hedge both credit positions and establish long exposures; and currency forwards for active currency positions as well as hedging to investor base currency.

The original strategy relies on a core diversified portfolio with between 800 and 900 securities, but at the behest of clients, Stone Harbor also created a more concentrated "best ideas" portfolio of 100 to 125 securities, Mr. Torchia said.

Stone Harbor managed a total of $35 billion as of Jan. 28 for an all-institutional client base, of which $5 billion was run in multisector fixed income and of that, $2 billion in the firm's MAC strategy.

Long-only MAC strategy

Credit hedge fund specialist CQS (U.K.) Ltd., London, was asked by an investment consultant to create a long-only MAC strategy for its clients in 2012, said Craig Scordellis, partner and head of long-only multiasset credit. With money from the consultant and seed investors, CQS managed a shadow portfolio for a year and formally launched its strategy in 2013.

Inflows have been "substantial" over the years, Mr. Scordellis said, with U.K. pension funds forming the initial investor base augmented over time by Japanese and Australian institutions and, more recently, by U.S. pension funds.

Assets managed in CQS' MAC strategy accounted for $5.5 billion of the firm's $14.5 billion in total assets as of Jan. 31.

"The big benefit of a multiasset credit approach is that it encompasses a very broad spectrum of possible investment strategies which allows you to really uncover sources of alpha," Mr. Scordellis said.

With access to the full credit liquidity spectrum, CQS' portfolio managers use a bottom-up approach to take more risk in credit instruments while the top-down asset allocation process manages portfolio weightings.

"The skill set from CQS' hedge fund heritage — the tactical nimbleness in identifying the right asset class in the right geography at the right time — informs how we manage the long-only multiasset credit portfolio," Mr. Scordellis said.