Defined contribution plans across Europe are embracing new components in their fixed-income portfolios to capture yield opportunities as equity returns are expected to fall.
Haunted by the low-yield/low-inflation environment, European asset owners are adding different types of fixed-income assets to their default investment options for the first time, DC plan executives said, hoping that emerging market corporate debt and private debt will help them diversify away from equity risk.
Developed markets equity is expected to return only 5% over the long term, while returns for emerging markets debt could range from 5.75% to 6% and high yield, 4.75% to 5.25%, according to estimates by J.P. Morgan Asset Management.
Net flows from defined contribution plans into emerging market active debt strategies stood at $2.8 billion in the 12 months ended Feb. 26, driven by Nordic and Swiss investors, according to data by Broadridge Financial Solutions Inc.
Earlier this year, one European plan, PenSam, Farum, Denmark, a 140 billion Danish kroner ($21.2 billion) multiemployer plan for elder care, technical service and education workers, selected a manager for its emerging markets corporate debt allocation, said Jannik Teigen Hjelmsted, head of liquid assets and portfolio analysis.
"It's a new allocation," he said, adding that the fund also is in the process of adding additional private debt. "We see our illiquid credit and hard currency EM corporate debt attractive in terms of risk/reward, and it aids diversification of our portfolio.
"It is our philosophy to make strategic allocations, rather than tactical choices," he added. "Our decisions are based on what we think is the most robust for our portfolio long term, including when adding a new asset class or market." Mr. Hjelmsted declined to provide details of the allocation and the manager hired. U.K. plans also are adding more fixed income to their existing holdings.
The £5.5 billion ($7.3 billion) National Employment Savings Trust, London, is in the process of completing a private credit search, a new allocation, said CIO Mark Fawcett. "We are appointing managers for infrastructure debt, private real estate debt and loans. We're looking to announce the successful managers in May."
The fund also just launched a search for global investment-grade credit. It already has a sterling corporate investment-grade bond fund, he said.
Because of U.K. rules starting April 6, mandatory minimum employer and employee contributions will increase to 8% from 5%. As a result, NEST will be taking £450 million more in contributions a month.
"Given the flows that are coming in, we want to diversify from sterling corporate bonds to global corporate bonds — and hedge back into sterling," he said.
"Some of (the additional contributions) need to be allocated to corporate bonds. We want to make sure we are not disturbing the market and that we are diversifying sensibly," Mr. Fawcett said.
NEST currently has about 21.5% of its assets in fixed income, made up of 3.9% in emerging markets debt, 4.3% in global high yield and 13.3% in sterling corporate bonds. NEST expects the fixed-income allocation to increase by about 5 percentage points with the addition of global investment-grade corporate bonds, according to its spokesman. The size of private credit has not yet been decided.