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Are there enough credit opportunities to go around?

Investors are all talking about the same thing –that alpha will come from selective opportunities and implementation techniques within sectors, and the next year will be less about strategic or beta bets. Specifically credit opportunities remain front and centre of the collective investors’ radar.

Managers, it turns out, are all also talking about the same thing – unconstrained fixed income – which is the all-encompassing version of what investors are looking at.

But, at least from what I see, investors want to be opportunistic and nimble, which raises the question of whether there are constraints within the confines of an unconstrained mandate?

At least three corporate pension funds I’ve spoken with recently, in the US and the UK, have been employing interesting opportunistic and entrepreneurial spirit in taking advantage of some of the fallout in the banking sector.

Where traditional sources of lending have dried up, pension funds are acting directly as sources of liquidity, and in some cases making really good returns in short time periods.

A couple of examples include the £5.5 billion ($9 billion) Centrica corporate pension fund which has been actively involved in direct lending, mezzanine financing and senior loans.

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The fund allocations are driven by the best way to achieve return targets and investments are allocated to asset classes on a bottom up basis, aggregating up to percentage holdings in return-seeking and liability-matching. It doesn’t fill asset class buckets, which means it can allocate freely and quickly.

Similarly the $28 billion United Parcel Service corporate pension fund has made new investments to structured credit, bank recapitalisation strategies, and an investigation into ownership interests.

It has a specific 10 per cent allocation to opportunistic liquid alternatives, and the lack of liquidity constraints the fund has, partly because of a young membership, combined with the ability of the private markets team to evaluate opportunities, and the flexibility to commit capital quickly has meant the fund be active.

Both these funds are very dynamic and are focusing on the ability to be opportunistic within sectors, rather than strategic. While they also have unconstrained mandates with managers, they seek to allocate opportunistically on a direct basis.

In Australia the $26 billion Sunsuper is also looking actively at direct investing, and its behaviour is testament to the shift in the way asset owners are approaching investments, acting more like a bank or a private equity firm than they have in the past.

In one co-investment deal the fund invested $15 million in and within two months it got back $45 million.

In the past couple of years the fund has increased its allocation to distressed debt which has returned 16.7 per cent return per annum since 2004.

It’s the kind of stuff the really big pension funds, like CPPIB, PPGM and APG, have been doing for years, but is now a part of the mid-to-smaller fund’s investment activities.

In addition to these pension funds acting more like lenders, this behaviour has also influenced the way asset owners are working with their providers – they are more patient, waiting for the right manager’s offering to suit the opportunity, and more willing to negotiate fees.

The University of Toronto Asset Management, which manages the endowment’s $6 billion, made a significant tilt last year away from traditional credit in investment grade and high yield and more into specialised strategies and products such as direct lending, and structured credit.

The move was inspired by looking at areas of the market which have more complexity and dislocation but not the flow of liquidity.

If the market conditions of high volatility, low interest rates and changes in government policy continue then this seems to be a natural fit for the profile of asset owners which have large balance sheets and low liquidity needs.

But the view of one investor that has been playing the credit market for some time, the $50 billion Healthcare of Ontario Pension Plan, is that corporate credit spreads are as tight as they were in 2007, which means there is not as much pay off to take risk.

Similarly the latest credit report from Morgan Stanley issues a warning about the prospect of a rise in interest rates. and the effect on the more traditional credit space.

It says that despite richer valuations, credit spreads could slowly grind tighter over the coming year or two. And it also says that high yield would also be the strongest performing asset class again.

For investors playing in credit it’s a reminder of how fickle, complicated and volatile the markets can be.







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