Data crunch: Fixed income isn't so boring anymore, as the low yields force funds to change their strategies, says Spence Johnson's Magnus Spence.
Recent advances in data analytics in the European institutional investment landscape mean we can now see with greater clarity how institutions are investing when they outsource to third-party managers. This article explains how fixed income usage is changing.
The first chart shows total fixed income investments in institutional portfolios across Europe managed by third-party asset managers in 2014 and 2016. At the end of Q1 2014 government bond strategies accounted for 27 per cent of third-party managed fixed income assets, but by the end of Q2 2016 this had fallen to 23 per cent – a drop of 4 percentage points over 15 months. Corporate credit fixed income rose over the same period by 3 percentage points to 37 per cent, and absolute return from 2 per cent of the third-party managed fixed income portfolio to 5 per cent.
More illiquid strategies like private loans, or insurance-linked securities, are also gaining traction as Europe’s investors look for solutions to low yields in traditional liquid fixed income markets.
Of course this does not in itself prove that institutions are divesting from lower-risk fixed income; they may in fact be holding more government bonds for regulatory capital reasons and managing these in house. But what it does show quite comprehensively is institutions are moving into higher-risk assets that bring them new and, in many cases, previously unknown governance challenges, which they are looking to third-party managers for assistance in addressing.
The shift into corporate credit strategies we have identified sheds further light on this governance issue. The second chart shows flows of institutional assets into third-party managed strategies. Investment by institutions in corporate credit is predominantly into global credit mandates, and there are negative flows away from European developed market credit strategies.
Clearly we are seeing a shift towards wider-ranging global strategies, allowing managers to be more unconstrained in the hunt for yield and transferring the governance challenge for this demanding task to external experts.
Changes in fixed income DB strategies
In the UK specifically we are seeing evidence that defined benefit plans are using multi-sector strategies as an equity replacement. Multi-sector strategies, also known as multi-asset credit strategies, rotate among different credit sectors and use more illiquid and specialist fixed income strategies.
There is an increasing use of cash plus multi-sector credit strategies as they look to maintain growth but diversify from equity risk. In the chart below, the flows of both corporate credit and multi-sector fixed income absolute return assets into third party managers are illustrated. The flows have been positive in every quarter since Q3 2014 for corporate credit, and only recently have become negative in multi-sector.
At a time when we sometimes hear DB schemes are shrinking and reducing their use of active investment products, it is useful to remind ourselves that there are significant pockets of activity where this is not the case. The next step is to explore the reasons underlying this trend.
Magnus Spence is managing director of Spence Johnson
