Positive returns from traditional return-seeking assets like equities have failed to improve funding lev-els as falling interest rates have increased liability values. This does not necessarily mean traditional assets should be discard-ed. Instead, pension schemes can benefit from new approaches to investing in such assets. One of the key areas is credit, where increasingly illiquid and oc-casionally volatile markets continue to present a range of opportunities.
Multi-class credit (MCC) is an ap-proach that aims to find the best individual opportunities across a wide range of credit assets, across all parts of the capital structure. The strategy provides exposure to credit over the cycle, rotating through the credit spectrum in periods of market stress as well as through good times.
The below table shows where we believe MCC fits in comparison to other credit strategies, ranging from traditional benchmark ap-proaches to long-short credit hedge funds. At a high level, MCC is quite similar to other strategies in more liquid asset classes. For example, diversi-fied growth funds (DGFs) are gener-ally driven by the manager’s assess-ment of relative value between asset classes. In this respect, MCC can be regard-ed as a ‘credit DGF’, as in the man-ager’s ability to move between opportunities.
We would argue it is important to have a bottom-up (starting with individual opportunities and their relative merits) rather than a pure top-down approach. It is tempting to assume a manager will always outperform by being in the right asset class at the right time. However, this is very difficult to do well consistently, and ignores the fact the most interesting relative value opportunities are often within asset classes, not between them.
Five key benefits of a multi-class credit approach1. Wide asset range. Accessing all parts of the credit universe and capital structure. 2. Benchmark agnostic. MCC does not aim to passively repli-cate benchmarks; instead it aims to find the best individual opportunities. 3. Dynamic asset allocation. Credit performance varies year to year; dynamic switching between credit asset classes can provide better and smoother returns. 4. Strategic efficiency. Allows pension schemes to invest in credit with a degree of flexibil-ity and a breadth of opportuni-ty that might be challenging to replicate internally. 5. Specialist skills. MCC offers good diversification, but ensur-ing the manager has the right skills is key.
The challenge is how to differenti-ate between the various offerings. From our proprietary 10-factor screening process, we believe the following three factors to be partic-ularly important: screening ad-vantage; decision-making ad-vantage; conviction advantage. Provided you identify a manager with the right skill set, MCC can provide an effective way of gener-ating higher returns from credit than traditional strategies.