A multi-asset credit (MAC) allocation can provide advantages to investors during times of market disruption and when alpha is difficult to come by. The goal is to generate excess returns over a cycle rather than positive returns during all time periods.
As interest rates begin their steady climb, MAC can allow investors to shift between fixed versus floating rate assets. But this shouldn’t be the only focus when managing risk within a MAC allocation.
MAC offers the flexibility to move across the capital structure and geography to mitigate risk, depending on assessments of what stage the credit cycle is in. For example, when valuations are expensive (or spreads are relatively tight), investors might do better to migrate up the capital structure because they’re getting paid less for taking incremental risk (such as leveraged loans, which have better drawdown characteristics). When valuations are cheap, it’s better to move down the capital structure into high-yield bonds, which offer greater compensation for taking risks.
Of course, like any investment approach, certain risks apply. MAC has embedded credit beta exposure and will likely experience periods of negative returns. MAC also typically involves assets with higher credit risk, such as high yield and leveraged loans, which are typically below investment grade. And key components of MAC can become highly correlated during a drawdown. For example, while investment grade and high yield do not appear to exhibit much historical correlation, they are highly correlated during periods of market volatility. So when investors most desire the benefits of diversification, correlations increase across asset classes.
Periods of relative illiquidity can also pose challenges. For example, within high yield, while the size of daily trading volume has increased over the last 10-15 years, the actual liquidity conditions have deteriorated, as the trading volume as a percentage of the high yield asset class is now about 80% of what it was pre-crisis. The volumes largely reflect the trading in the massive supply of new issuance when exchange-traded funds (ETFs) and other managers resize their portfolios based on new issue allocations. After the initial weeks of issuance, the secondary market liquidity becomes severely constrained and the average size per trade also decreases. This decline in liquidity requires a MAC allocation to be sized appropriately to take advantage of value dislocations.
Trading volumes are up but liquidity conditions have declined relative to market size.
Source: BofA Merrill Lynch Global Research, TRACE FINRA as of 20 December 2017. Average trading volume based on a 30 day moving average. 144A trace volumes are estimated pre 2015. For illustrative purposes only. We are not soliciting or recommending any action based on this material.
Essential to managing risk is the manager’s strategic view of where we are in the economic and credit cycle. At PineBridge, we take more of a defensive posturing, preparing for the downside because fewer total return opportunities are available in the broader market.
Investing involves risk, including possible loss of principal. The information presented herein is for illustrative purposes only and should not be considered reflective of any particular security, strategy, or investment product. It represents a general assessment of the markets at a specific time and is not a guarantee of future performance results or market movement. This material does not constitute investment, financial, legal, tax, or other advice; investment research or a product of any research department; an offer to sell, or the solicitation of an offer to purchase any security or interest in a fund; or a recommendation for any investment product or strategy. PineBridge Investments is not soliciting or recommending any action based on information in this document. Any opinions, projections, or forward-looking statements expressed herein are solely those of the author, may differ from the views or opinions expressed by other areas of PineBridge Investments, and are only for general informational purposes as of the date indicated. Views may be based on third-party data that has not been independently verified. PineBridge Investments does not approve of or endorse any re-publication or sharing of this material. You are solely responsible for deciding whether any investment product or strategy is appropriate for you based upon your investment goals, financial situation and tolerance for risk.