Fixed income roundtable: Changing times


Chair: Paul Cavalier Global Business and Investment Leader, Mercer’s bond boutique

Bernard Abrahamsen, Head of Institutional Sales and Distribution, M&G Investments

Stephen Cohen, Chief Investment Strategist, International Fixed Income & iShares EMEA, BlackRock

Giles Craven, Associate, BESTrustees

Ciaran Mulligan, Global Head of Manager Research, Buck Global Investment Advisors

Zak Summerscale, CIO of European High Yield, Babson Capital

Andrew Jackson, CIO, Cairn Capital

Colin Richardson, Client Director, PTL

Paul Whelan, Senior Fixed Income Manager Researcher, Aon Hewitt

Chair: What are your current thoughts on the market given the current low interest rate environment, tightening credit spreads and the increase in geopolitical risk around the world? At Mercer, we’re seeing greater demand for non-traditional approaches to investing - clients are moving away from traditional aggregate or investment grade credit mandates, and taking more of an absolute return approach.

Abrahamsen: One of the key things that we have long known is that benchmarks per se do not pay liabilities, so understanding what it is that we need to deliver in order to make good against the promises that have been made - whether that’s pension fund or insurance company liabilities - is important.

Something that we always focus on is whether or not we’re being paid to take the risk that we’re being asked to take, irrespective of what asset category within fixed income that falls in.

Richardson: We’re seeing a variety of approaches, depending on each client’s circumstances and their desire to match more exactly, or whether they have the appetite and the medium-term time horizons to take risks within the tolerance of the risks available. Generally speaking, there are more clients seeking different approaches rather than those seeking to constrain risk tightly without those different approaches, because of the need to sweat and increase yield where possible, subject to the risk tolerances they have.

Cohen: This year is quite an interesting year in fixed income because everyone you speak to, whether they are a retail investor or a pension fund or an insurance company, has been surprised by how well fixed income has done. There are going to be a lot of people who, when they look at their first half period - particularly if they’re a multi-asset investor – will realise that fixed income delivered much of their returns so far.

But actually yields are incredibly low and therefore this yield hunt that we’ve become so accustomed to within fixed income, and everywhere else as well, potentially is going to take on a new leg for the rest of the year - that’s going to come as a shock to a lot of people.

Craven: My clients, since 2008, have done quite a lot of re-risking but now it’s all about educating lay trustees about de-risking. We are investing an awful lot of time in making sure the trustees understand areas that have not hitherto been part of their lives – LDI buckets and that sort of thing.

For people who haven’t been involved in this before, the learning curve is quite steep and I’m finding I’ve got to take this at quite a modest pace vis-a-vis the members of the investment committee because I don’t want them to have any surprises.

Cast your mind back to 2008. I was involved in a plan that did a significant de-risking exercise in 2007, which was a very good time to do it, but what happened in 2008 was that the fixed income they had bought behaved liked equities and this was absolutely terrifying for them.

Whelan: I agree – some of those clients who have re-risked over the last three to five years are now approaching de-risking, given where they are from a funding status. I also agree we are seeing a shift more towards unconstrained absolute return strategies.

Clients are increasingly nervous on credit beta and the outlook for credit excess returns. Also, some of the traditional asset classes that many of our clients have looked at look quite elevated in valuation terms. So I would say LDI is a big topic, and echo the point that education is key.

We have been trying to work together with managers, take a more unified approach, in order to come up with more holistic client solutions rather than just the traditional options that have dominated the space over the last five, 10, 20 years.

Mulligan: Fixed income is falling into two categories it would seem. You have the somewhat newer asset classes offering growth to a pension fund portfolio - emerging market debt (EMD), absolute return bonds, all contributing to the search for yield for example – within these asset classes we see a greater proliferation of accessible funds available for medium-sized pension schemes to invest in, which is really good, and that’s both in the liquid and illiquid space.

Then you have the more traditional asset classes - such as tailored LDI solutions, gilts, credit and so on. Given that the long-term game for pension funds is still a de-risking one, there will always be a place for these more traditional asset classes as part of those de-risking programmes.

One of the concerns that I have from a manager research point of view is that often the talent in some organisations can actually lend itself more towards the newer asset classes, so one has to be cognisant of who is actually running the more traditional fixed income funds that some organisations have built their reputation on as newer asset classes become more in vogue.

Jackson: On the theme of education, a lot has been done already. The pension fund community that I speak to today is a lot more educated about some of the more complex areas of fixed income markets than, say, five years ago. There is more awareness of risk, more understanding of absolute return, and this is the case in the UK, in Europe and in North America.

The second observation I would make is around markets. We’ve talked a little about liquid markets and traditional benchmark liquid markets, and the non-traditional, non-liquid markets. Those two markets now behave in a completely different fashion - there has been a huge amount of polarisation between the two. Liquid markets trade at all-time tights – if you look at iTraxx Crossover, our benchmark index in Europe, it is near all-time tights. That’s staggering. And if you think about liquid investment grade (IG) bonds, maybe they’re not quite at the all-time tights but in terms of high yield bonds you’ve never been paid less for your risk.

But outside of that arena, in the more non-traditional, less liquid, more complex assets, you’re still getting paid more than the fundamentals would suggest and that’s where pension funds need to challenge themselves - you can de-risk but take a more bar belled approach. More and more we’re seeing pension funds happy to contemplate giving up some liquidity in return for some return because, after all, they still need to make money. It’s all very well talking about de-risking, but they still need to make some money in order to reach their run rate.

Summerscale: What we see from clients is still the need for attractive yield. In terms of what the big trends have been in the last few years, I believe people are appreciating what senior secured loans are and, for the first time, really starting to invest, in a reasonable size, in the loan asset class. This makes a lot of sense to us given the relative value of that against high yield.

More recently, we are seeing a greater move towards global multi-strategy credit - a lot of investors now want to offset the risk of getting it wrong or being in an asset class that was attractive 18 months ago but no longer is. So we’re seeing a big trend towards investors/pension funds wanting to outsource that to the manager and we’re running multi-credit asset mandates for those investors in sub-investment grade credit, looking to access both the US and European markets through a single fund.

I would probably take issue with what Andrew [Jackson] said in terms of never being paid less for risk. I actually think, in things like high yield bonds, we are not at the kind of leverage points we were in 2006/7, we are not back to the excesses that we saw then. But clearly this is about idiosyncratic risk today and for us it’s a huge opportunity to outperform as an alpha fund manager.


Chair: Are there any regulatory or legislative changes that are preventing the market from moving ahead?

Cohen: One thing that I would highlight is that, depending on your definition of UCITs (so maybe for a broader audience rather than a pension fund specific audience), the ability to go into things like loans is still restricted. In fact, that is probably one of the reasons why it is a part of the asset class that is less researched and less well known, which potentially leads to more opportunity.

Jackson: The CLO market has probably helped that too as it has been a very regulated market recently. The risk retention rules that we have seen - the 122(a) rules in Europe and the Volcker rule in the US - have prevented the CLO market from growing as much as it would have and is probably another reason why loans are, to our mind, better value than high yield bonds.

Chair: Focusing on the CLO market, that was obviously a market that was closed in 2008/9, especially in Europe. In the US, it picked up a number of years ago but in Europe it’s only starting to do so. What do you see as the benefits for an institution investing in a CLO?


Jackson: The difference between investing in a loan fund and a CLO is what the underlying manager can do. In a CLO you can hold. A CLO is not a mark-to-market fund and, as a manager, what you want is the ability to manage loans through those periods of volatility.

One observation I would make is that, while CLOs did have a rough time in 2008/9 in terms of valuations, European CLOs have continued to make payments on their rated debt. So they did what they were supposed to do and they gave the managers flexibility.

In comparison, if you were an investor in a loan fund, whether that be in the US or in Europe, most of those applied a degree of leverage to them. And that leverage provided was normally with mark-to-market triggers.

Today we are getting to the point where people will do loan funds without mark-to-market triggers and they look very much like CLOs, but if you have a mark-to-market trigger on a loan fund, that’s an incredibly dangerous thing, because loans are significantly less liquid than credit default swaps or bonds and you don’t, as a manager, want to have to liquidate into a market which is declining. Those mechanisms were one of the things that were very damaging to the loan market and the perception of the loan market in Europe.

So there is a place for CLOs. They are not without risk and there’s a huge amount of education that needs to be done; but as an investment versus a single loan or five underlying loans, or a loan fund which has market value triggers, it is a reasonable proposition.

Abrahamsen: You could argue that we have not seen any negative things coming out of CLOs, particularly on the junior side, because we’re still in the middle of the debt crisis in Europe, compared to the US where a lot of the pain has actually already been felt and restructured.

Jackson: But leverage on the underlying borrowers is very low and affordability is very high. If you look at interest coverage ratios on most leverage loan borrowers, they are off the charts. They can afford to pay their debt. The loans that you see within CLO 1.0s, they are very high quality and a lot of the pain has been taken. I’m not saying there is no risk, I’m a bear, but if you look at the interest coverage ratios and the affordability, leverage loans look great value.

Abrahamsen: What we are also seeing is that there’s a lot of M&A coming into the market. Companies are under pressure to manage for their shareholders more than their lenders, which means that leverage is actually creeping up and covenants are becoming lighter and lighter. These are all aspects, as an investor, that I would be a little bit concerned about and which show it’s not all a bed of roses. So, the valuations might be attractive, however investors still need to make sure that they haven’t altogether forgotten the lessons learnt, if they did learn them, from the previous financial crisis.

Summerscale: I’d agree on that, on the 1.0 CLOs, there have been some problems. Overall the credit quality is very high but there are still problem cases that come up in the market.

Saying that, in a widely diversified new CLO transfer, you’re not taking those kinds of risks, so the 2.0s that have been done are new deals with much lower leverage, far better structures, much higher running yields and we think they’re incredibly attractive.

Chair: Focusing on the advisers around the table, what sort of advice have you given your clients on how to access high yielding asset classes in general because obviously there has been this huge hunt for yield?

Whelan: UK pension funds have, on average, 20/23 year type liabilities, yet there’s still a great thirst for having weekly, if not daily, liquidity on 100 per cent of assets, which we feel is not pragmatic, nor required.

Saying that, some are starting to look at more illiquid, less mark-to-market asset classes, such as CLOs and increasingly real estate debt. We’ve been a bit more sanguine on infrastructure debt.

So we believe that the general de-risking that has been happening by the banks has thrown up opportunities in some of these less liquid asset classes.

I’m sure we all have different views on high yield and whether the spread or yield does compensate you adequately for risk, but in the case of some asset classes such as the triple-A rated CLO tranches, mezzanine real estate debt, there is a lot more of a fundamental compelling reason there and a valuation that stacks up.

So to some degree, investors are looking to increase allocations to some of those asset classes from close to zero.

Emerging market is still not the most liquid of investments, especially on the local side, but 5-6 per cent is still probably not an unrealistic return expectation for investment grade quality. And there’s still reasonable liquidity if investors do change their minds. Again, it comes back to having an education and understanding of the risks.

Mulligan: I agree that here education is key. Trustees need to understand what it is they are actually investing in. A lot of trustees may shy away from some of these more complex solutions because of a lack of education and understanding which is a shame.

Also, what you need to do with any trustee board investing in any asset is to try and avoid any undue surprises three or four years down the line when then they realise what they have invested in.

There are key asset classes for pension funds - traditional equities, gilts, credit, property - and there is a place for EMD, for high yield and for other fixed income orientated asset classes, it’s just a question of where they fit into the overall portfolio.

Also, the smaller to mid-size portion of the market may not want to take the risk of any one individual investment. So we’ve seen interest in multi-asset investments – high yield and loans funds for example, or an absolute return fund where you can access these areas but not necessarily take the individual risk within those funds.

Chair: One of the interesting points in the valuations that we’ve been facing quite a lot is that spreads have come in but what’s even more expensive is the outright yield that you are actually earning. When it actually comes to a potential default, you had some protection when the yield was 7 or 8 and spreads were tight, but now you don’t have any more protection than you used to and that’s the biggest risk to clients.

Cohen: It’s a risk in terms of defaults but the biggest immediate challenge is the challenge in terms of the return you are getting. Looking through the cycle, defaults is going to be an issue at some point but we don’t see any risk in the next, say, 12 months.

The immediate challenge is effectively what’s happened in the last six months. Everything is yielding below the levels it’s ever yielded and whether it’s fair value, expensive or rich, it is what it is. So the challenge, particularly if you are running a multi-asset portfolio for a pension fund, is where do you go next to get yield, how much liquidity or illiquidity risk are you prepared to take on before that? How do you balance that within the portfolio? The default comes later than the immediate ‘when am I going to get a return’?

Liquidity versus illiquidity

Chair: What is the current appetite for illiquidity within a client’s portfolio? There has been a huge move into private equity but increasingly we are seeing more and more demand for private debt, infrastructure debt, real estate debt – areas of the market that traditionally UK pension funds haven’t been interested in.

Richardson: I don’t think it’s an appetite, but a lack of aversion. The general point that was made earlier about some pension funds needing to take on more illiquidity is a valid one, but schemes need to assess with their investment consultants what liquidity might be needed in three, four or five years and so on. In most cases it won’t be much, but in some cases it might be, for example, if they are heading towards potential insurance transactions.

In general terms they need to be prepared to invest part of their assets in things that are more illiquid.

It’s all about inertia. UK trustees have had more investment education than five, 10, 15 years ago, but it has been a journey to get to the current point, and the current point is still not perfect and varies from scheme to scheme.

There are opportunities out there that schemes should be taking, within reason and with the right scheme and under the right circumstances, but there is a large onus on the investment consultant to bring to the table new asset classes that may be of interest to that scheme, and together educate the scheme in order to enable the decision-making process.

Craven: The picture that I have heard from consultants is that ‘if you buy such and such an asset class, you are getting this and this - whatever the good things with that asset class may be - but you should be aware that there is some illiquidity attached’, so that illiquidity is not the driver for the selection, it is a second order issue.

But I have certainly noticed an appetite for illiquid assets. A daily need for liquidity across a multi-million pound pension fund has not, for me, been a driver, but the education of what are the consequences of illiquidity has been key. It was pretty terrifying in 2008, when you found you couldn’t sell anything, even if you wanted to, and so you sold your large cap stuff and you got out of kilter because that was the only stuff you could sell in order to do what you needed to do.

Abrahamsen: I don’t think the world is as simple as liquidity versus illiquidity because back in 2008, arguably investment grade bonds were mispriced. You didn’t get the liquidity that you thought you were buying, so there might be a mispricing in the market there and the market was a bit stretched. Also, liquidity is not only about the ability to realise an asset on day one or day two, but it can be throwing off an income stream that I would be perfectly happy with to provide the liquidity that I need, whether it is pensions in payment or otherwise, so there is that kind of liquidity - safe in the knowledge that the underlying credit fundamental of the security that I am invested in is going to be good at time of maturity, then I can suffer that mark-to-market risk.

But investing in illiquid assets for the sake of investing in illiquid assets, just because there is a premium versus more liquid assets, is completely the wrong idea. You have to be convinced that over the holding period you are better off in that illiquid asset.

It all comes back to the question of whether you are being rewarded for the risk you are being asked to take, in this case the illiquidity. It doesn’t mean to say that there aren’t elements of illiquid credits out there that present fantastic value, but you do need to take a holistic view as to what those might be.

Summerscale: We would very much agree with that – there are a wide range of funds now being raised that are saying ‘we want you to lock up capital for five years and we are going to keep on reinvesting, and finding this illiquidity premium’, a premium which is not always there. As an investor you are signing up to something today which means that your manager can carry on investing at times when it may not be wise to invest - but if you have got a mandate which is purely focussed on illiquid credit, you have counter pressures on yourself as a manager to invest in assets even when there is no longer the illiquidity premium available. Investors in these strategies therefore need to be aware that, just because there is a premium today, does not mean they will get that premium for the life of the vehicle to which they are committing.

Passive versus active

Chair: Is passive management the best way to access some markets?

Cohen: What we are seeing across the industry is a shift towards, on the one hand looking for cheap indexing, in whatever form that may be - it is different for different types of investor - and then where you are actually spending your risk budget and your fees, focusing on managers who can deliver alpha; and that recognition of what alpha is versus what beta is has changed a lot in the last five or 10 years and will continue to change.

The example within fixed income is this shift towards unconstrained fixed income which is, to me, part of that shift away from being very benchmark constrained towards saying to a manager ‘you have the capacity within a mandate to be more diversified, go anywhere, to generate that alpha’. So it is as relevant in fixed income as it is in the other asset classes.

Summerscale: What I have always found slightly perverse about credit indices and tracking is that you are tracking to whoever has the most debt. So in sub-investment grade credit you are actually trying to chase who is the most levered company; in equities it’s the biggest market caps at quality companies.

In passive credit strategies you are therefore trying to take the risk that you shouldn’t be wanting to take; as an active sub-investment grade credit manager, we look for the exposure to the companies that have reasonably low leverage and good cash flow. You simply don’t get that from a passive portfolio.

Saying that, we do welcome ETFs in the market. They will help generate alpha; they will also help the fund management market to sharpen up its act, because a lot of people have been charging high fees without delivering appropriate performance.


Chair: At Mercer, we think there is alpha to be had with these high yield esoteric asset classes. The overall return of that asset class is very much beta dependent though, and one of the things that we have been talking to our existing managers on is fees. When you are looking at a fee structure when yields and returns were in the 5-6 per cent range in investment grade debt, and 8-9 per cent high yield, the fees you were generating were, say, 30 basis points and 60 basis points. Now that actual returns looking forward are half that, the fees remain the same. Yes, as an investor, you are still looking for alpha, but the majority of the return is made up of beta. Should the fees not be changed because of that?

Jackson: You pay a credit manager to avoid the screw-ups, not to make money - that is the first thing I would say. You shouldn’t worry about fees versus return, you should be worrying about fees versus the quality of the insulation against the drawdowns.

Second, if we get into this circular argument about returns versus fees, eventually what happens is that managers say, ‘OK, I can give you some leverage then, in order to achieve the return that gets me the fees’. So that is dangerous.

Following this, the investment manager becomes more and more passive in their management approach and that is one of the dangers with passive versus active - we will all be chasing the same assets in as passive a manner as we can in order to do it as cheaply as we can.

It is really tough but we are having big debates with all of our pension fund clients. What we end up telling them is to pay us a slightly lower management fee, but pay us a performance fee, but pension funds really struggle with that. While fund of funds are very comfortable with that concept, and understand the performance fee, pension funds feel a little uncomfortable with it because they think it provides the wrong kind of motivation, but for us it feels like the right way to meet both of our needs - lower management fees, higher performance fees. But performance fees very much related to avoiding the big drawdowns, and if you can get paid for avoiding the big drawdowns, I think that is the right way to structure it.

Whelan: So over what time horizon would that be?

Jackson: You would make the performance fees back-ended. Make the performance fees fit the investment thesis. So if the investment thesis is to invest in some CLOs, make it over the life of the CLO investment. Pension funds and trustees need to become more savvy to alignment of interests, transparency, rewarding good behaviour, and encouraging good behaviour.

Craven: I am not comfortable with performance fees generally. It produces the wrong behaviour.

Richardson: There are reasons why trustees find them difficult and you know those reasons. If we talk about the overall high risk and the asymmetric risk of high yield classes and CLOs and so on, the performance fee which doesn’t serve to shield you from that asymmetric risk is not performance/target generated. Of course there is always scope for discussion, but there is not a strong enough case normally for a performance fee to outweigh that - there is plenty of incentivisation anyway, which is the power to hire and fire.

Mulligan: If I pay a manager a fee, I expect him to do his best. I don’t think necessarily he should do a better job because I am incentivising him with a performance-related element. In terms of managing drawdowns, he should be doing that because he has got a duty to manage the fund to the best of his abilities.

The issue with fees is that you see quite a dispersion of returns within the fund management industry and within fixed income, and when people talk about fees it is always about managers in aggregate, but we should be putting the onus on trying to identify those managers who deserve those fees, top quartile or consistently second or first quartile managers.

Cohen: Yes - the structure of the industry on the active side so far has seen a pretty standardised fee for a lot of things, even though the actual performance across managers has been incredibly different. And the way the industry should go, whether it goes there or not, is that you pay for performance.

On the passive side, pressure on costs is immense; and so where we are seeing a lot of the growth is around things like screened mandates - so how do you move beyond what you would typically define as your basic passive i.e. market-cap weighted index, towards something that is much more tailored to that institution? Again that is where institutions are prepared to pay for that if the methodology makes sense. So the whole passive world is changing as well, with the same pressures that are impacting the active world.

Multi-asset credit vehicles

Chair: Within Mercer we are seeing increased demand for multi-asset credit vehicles which incorporate things from high yield loans, convertibles, asset-back securities, emerging market debt and so on. What we have found difficult is finding a manager who is good at all those different asset classes, and how to actually best serve our client base by producing that type of fund.

Mulligan: If you look back to when multi-asset DGF funds became popular, everyone was running to launch one, even if they were lacking certain disciplines within their investment house to put them together and then, more latterly, with the multi strat credit funds, it has been a similar experience. So there have been quite a lot of new product launches but when you actually assess the individual capabilities behind those funds, something inevitably breaks down. In theory, it is a nice idea and there is an increased amount of products there for clients, but actually having the faith that the fund chosen will produce what it’s meant to produce over the medium-term is becoming increasing difficult for trustees without expertise or consultants without the resource allocated to such tasks.

Abrahamsen: As an industry, we need to be careful about diversification for diversification’s sake - thinking that a broader opportunity set is going to yield the results that you think it will yield. For example, if we just focus on a very small component, for illustration purposes - infrastructure debt. Is that public? Is that private? Fixed? Floating? You can slice and dice infrastructure debt into so many different sub-components that you would hope that you would have more than just one person looking at it. And that is just infrastructure debt, before you come onto ABS which in itself you can slice and dice in terms of risk components, where it fits within the capital structure and the covenants that are in place and so on.

So it is not just about there being a great opportunity set, where you can flip from one to the other. It’s about making sure that if you are exposed, that you fully understand the risks you are being exposed to and that you can exploit them successfully.

Chair: What are your thoughts on multi-asset credits versus traditional benchmarks?

Jackson: It’s really, really tough. We have done a lot of multi-asset credit, but one of the really big challenges is when consultants come and see you and say they want the full pallet. As a manager there are areas that you feel that you have some expertise in and areas that you don’t feel you have expertise in, and just holding onto the conviction to say ‘look, we can’t do everything that you want us to’ is key. EM debt for example, is a fascinating asset class, but we don’t have the expertise there, so we just won’t do it.

But the other point I would make about absolute return and multi-asset is, despite what we all know about history, there are some shorts out there that are ridiculously cheap to put on and that is one of the big benefits of multi-asset credit. There are some asset classes and some trades that, irrespective of which path you draw from here forward, those shorts are going to do fantastically well against some of the longs that you have.

The future

Chair: Looking ahead – where do we go from here? What are the risks on the horizon?

Summerscale: It is a tough question. Markets today are pretty sanguine about inflation, about interest rate rises, and that gives me some concerns longer-term. If that whole sentiment changes, and not everyone has the same kind of belief, that tends to be when you get a lot of risk in the market.

People are also very sanguine about default risks today. So now is very much a time for active portfolio management, because there is a lot of risk now not getting priced properly into the market. Markets are sowing the seeds for another bubble, whilst I don’t expect it in the short-term, we are starting to see very poor deal structures come to market and people are getting complacent on risks that we have seen historically, in the search for finding yield.

Jackson: Technicals and complacency are the big risks, like they always are in credit markets. We are already seeing signs of a bubble-type behaviour. If you look at the CDS market versus the cash bond market, there are signs of complacency. Banks no longer do the traditional banking business - they are now offering leverage to the likes of us.

Also, a polarisation of politics within the European Union, coupled with some of the socioeconomic, technical and structural backdrops in the periphery of Europe mean that the issues that they face are not over – over 50 per cent youth unemployment in Spain is something that we should all worry about, and we have become complacent that Mr Draghi will be able to solve all of these problems.

The end of QE around the world is obviously something that we focus on, but quite often when these things play out, it isn’t the thing that we all focus on that causes the problem. The last one, which is a massive technical, is a lack of understanding of what will happen in China. That could be a positive or that could be a negative. But China is such a big factor in where the world will be in 10 years that we all need to be as educated as we possibly can be about what is really happening there. It is very difficult for westerners to get a good feel though for what is happening.

Mulligan: It’s clear to see there are a lot of unknowns out there - you mentioned China, you mentioned the bubble. There is a lot of risk inherent in those particular cases, and so we have to ensure that, from a pension scheme’s point of view, we are doing all we can to mitigate these risks by analysing what you think might be problems, and what will be the effect of a hard landing, what would be the effect of bubbles. Not just stress testing in a traditional sense but then recalibrating stress testing to the current environment, where we are in terms of the level of current yield curve and see how pension funds can actually protect their portfolios from each of these potential risks. For example, by incorporating an element of tail risk hedging where appropriate.

Whelan: I would add a greater focus on that risk element. If you de-risk now it doesn’t mean that you can’t re-risk later - the marginal cost of transitioning your assets from one form to another can easily be drawn off by the negative market movements which you could have. If you take those risks where you think they are warranted and are suitable for your scheme and are, most importantly, understood, then you need to try and mitigate as much as you can those risks which are unrewarded. The onus is on all of us in whatever capacity we work in to focus on education and ensure that trustees are in a position, with our guidance, to make the most informed decision that they can.

Craven: The first risk is that trustees can’t get their governance and accountability arrangements sorted out to fit with what they want to do, for example, on de-risking. Getting those arrangements sorted out is really quite a struggle, because they are going to have to do it differently than they have done in the past.

The second risk is that education doesn’t do the job and that trustees fail to act because they haven’t got the understanding, and they end up in completely horrendous places. So those are the two risks, from where I am sitting, that keep me awake in a fixed income world.

Cohen: The biggest risk is this complacency issue that has been mentioned – complacency around the ability of central banks to ever exit and ever normalise policy which is going to be much more challenging than people are currently positioned for. The challenge is that the longer that goes on, the harder it is to wait for it, because even as yields go lower, it is hard to be short carry and to run that over time and that is a major problem.

The complacency that is building up around China is also a huge issue.

The third issue is that the whole pensions industry is underfunded - we have an aging population, increasing longevity and unless you work in the industry, you don’t understand this issue. That is not a risk for the next couple of years, but over time is a massive challenge for society.

Richardson: Linked to that, over the medium term, most of the developed world, including the UK, still hasn’t got to grips with the fact that we are entering this period of demographic difficulty at time of high debt, when actually right now we need lower debt to be able to deal with this gradual increase in demographic costs. So I don’t think we can escape the fundamentals beneath that - there will be shocks and adverse conditions and sometimes significant shocks, even though we are six years on from the crisis and being able to deal with that is paramount.

Abrahamsen: Let’s look at what we have in front of us today. Interest rates are phenomenally low. You can deal with that aspect within your portfolio by taking that risk out; and then you look at credit spreads that have come in quite a long way. They are quite tight. If you look at high yield spreads, they are currently 275 over, and since 1997 we have crossed below 275 five times, and four out of five of those times we have lost phenomenal amounts of money. These things make me nervous.

So therefore you need to understand the risks that you are exposing yourselves to and exercise a degree of patience. It would be a pity if, when markets rerate themselves, a pension fund trustee or an investment manager is not in a position to be able to exploit those opportunities for want of insufficient patience.

But for the moment the risks are still asymmetrical on the downside and despite the fact that we have had five years of wonderful times within the debt markets, that is exactly the time when you should be most cautious about the risks that one is taking, and asking the question whether or not whether you are being rewarded to take those risks. Momentum investing, in my view, and passive investing in the debt markets are dangerous things.

Chair: From my point of view the risk is not learning from past mistakes and whenever we come out with or come across new ideas, as managers or consultants or finance specialists we need to take a step back and ask, more holistically, how does this product fit into our clients’ portfolios to best meet their needs?

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