Fixed Income:

Is This the Moment of Truth for Multi Asset Credit?

December 2017

bfinance insight from:

Mathias Neidert, CFA
Managing Director, Head of Public Markets Investment Advisory

Three years ago, we witnessed a wave of investment in Multi Asset Credit (or “MAC”) strategies. Not to be confused with Absolute Return or Unconstrained funds, which also experienced a surge in popularity, MAC products were marketed with a yield-boosting agenda and an eye towards upcoming rises in interest rates. In the simplest terms, they represented an exchange of interest rate risk for credit risk.

Yet the optimal environment for MAC – a climate in which rates are rising and credit spreads are narrowing – did not materialise as soon as many of these investors hoped. While monetary policy makers kicked the can down the road, MAC funds’ risk-adjusted returns largely failed to impress.

Frustrated intentions

Among 58 institutional MAC funds with a track record above three years (at October 2017), only 23 have produced a better three-year Sharpe ratio (assuming a risk-free rate of 1%) than the USD-hedged Global High Yield or Global Investment Grade Corporate indices. In terms of gross annualised performance, slightly more than half of the group have beaten global corporates and those beating the BofA high yield index could be counted on the fingers of one hand.

In addition, some investors have been frustrated by the lack of sector rotation, particularly around periods such as the energy price collapse and high yield debt crisis when allocation adjustments could have produced significant outperformance.

Managers’ theoretical flexibility to move tactically between different areas (corporates, sovereigns, high yield, bank loans, securitised credit and even, in some more aggressive cases, CLO equity, convertible bonds and private debt) represented a significant selling point for a number of clients. Yet a highly dynamic strategy is challenging to implement in practice because of the limited liquidity of some credit markets and the heavy use of derivatives that would be required.

So do these setbacks spell trouble for Multi Asset Credit strategies and future investor appetite for this sector? In reality, the opposite may well be true.

Positive prospects?

The aftermath of President Trump’s election has produced considerably more favourable conditions for MAC strategies, at least in theory. In 2014-15 oil prices tumbled to record lows, emerging markets were in the doldrums and high yield credit was experiencing something of a crisis. Yet in 2017 the situation has been reversed.

Importantly for the MAC premise, interest rates are now rising at last. The 2-year US Treasury yield has moved up about 70 basis points over the last 12 months. The ECB is about to cut its quantitative easing, which should gradually move the continent to a positive-trending rate environment. That being said, there are weaker grounds for optimism regarding spreads: it is hard to envisage significant further narrowing given today’s high valuations. Some MAC managers are positioned very cautiously at present, dialling back on both rate risk and credit risk, and cash allocations are high.

In addition, investors that examine asset managers in this sector – a very heterogeneous assortment with different return objectives and risk parameters – now have the benefit of significantly longer average track records to scrutinise. By our estimation, there are now 33 MAC products with track records of more than five years and 58 with three years or more: a very significant improvement versus 2014. This allows for more rigorous analysis of how managers have performed in different market conditions and where their strengths lie. It is also very useful that the past three years have encompassed a range of market conditions and events,

We also observe that MAC strategies do still provide a good method of gaining exposure to sectors that would not always be appropriate for standalone allocations, particularly for smaller investors. For example, many MAC funds have benefited over the past year from exposure to structured credit.

One might ask: is now the time for their original premise to prove its worth? This, perhaps, is the real moment of truth for MAC managers.