The benefits of multi-asset credit

Francesca Fabrizi meets Tom Raftery, senior product manager at Franklin Templeton Investments, to discuss multi-asset credit and the benefits it can offer pension schemes today

How would you define multi-asset credit and what type of funds are out there?

In terms of defining multi-asset credit, the name actually says a lot. At a very simple level, multi-asset credit investing is the idea that a fund will have a flexible mandate to invest across credit sectors, as opposed to just focusing on one credit sector.

In investing in multi-asset credit funds, investors can earn relatively high yields, especially compared to government bond funds or more traditional core bond funds. They can also harness the diversification benefits that come with blending different credit sectors.

In terms of classifying multi-asset credit funds, it's a bit difficult. It's actually a rather fluid exercise. The reason is that different managers will select different credit subsectors to invest in, so essentially there are no two identical multi-asset credit funds.

That said, looking at the investment manager's process and style is one way to categorise multi-asset credit managers. Another is to group them by the sectors that they invest in. But again, at a broader level, looking at the risk/reward expectation, and looking at the liquidity profile of the vehicle are probably the most common ways to define multi-asset credit funds.

What does multi-asset credit investing offer pensions schemes and why can't they just access the asset classes directly?

The most valuable things that multi-asset credit investing offers investors, whether it's a DB scheme, a DC scheme or even an individual, is a relatively high yield, compared to more traditional core or government bond funds and the combination of sectors in a multi-asset credit fund tends to produce a less volatile profile than investing in a single, high-yielding sector alone.

To your question about why would you hire an investment manager to do this, as opposed to doing it on your own, there are a few reasons. Firstly, it can be very time-consuming to manage the allocations. There are a number of different things that drive markets - geopolitical events, technical forces that come from investors all buying or selling the same type of idea, something that we've seen a lot more of as ETFs have grown in popularity. There are also fundamental reasons, whether they be driven by a particular industry or whether or not they're limited to a certain sector.

These are all things that a manager that can act quickly, that recognises these opportunities, can take advantage of. Investment managers have a lot of resources devoted to this asset allocation exercise, whereas the individual investor may not.

Lastly, it could be less cost efficient to try to access all of these different investment opportunities on a standalone basis, as opposed to buying them within one multi-asset credit fund. That less efficient cost could come either by investment fees or perhaps by the minimums on certain types of investments. It may just be more difficult, from a regional perspective, or something similar, to access certain types of investments.

How does a multi-asset credit manager generally decide which asset classes to invest in?

There are two generally accepted principles when it comes to multi-asset class investing. The first is that the investments are corporate in nature and the second is that the fund has a relatively high yield. So most government bonds are eliminated, based on those two principles. Most multi-asset credit funds look to high-yield corporate bonds and bank loans, on either a regional or global basis, as the ballast for these types of portfolios. The reasons are that both have a relatively high yield and both are among the larger opportunity sets within the fixed income universe, so they're relatively liquid.

Combining those two also has very notable diversification benefits. High-yield corporate bonds have a fixed interest rate, so they carry some interest rate duration, while bank loans have floating rate interest coupons, which reset as interest rates move around. So bank loans naturally can be a good investment when interest rates are rising, while the opposite is true, or can be true, for high-yield corporate bonds.

From there you tend to see any number of strategic or opportunistic allocations. Some managers will separate emerging market debt as an asset class. Others will consider that within their high-yield or bank loan allocation. Some managers will invest in convertible or preferred equity. Some managers opportunistically invest in equity although, to a lot of consultants or advisors, that might merit a different classification. There's also a private debt component. Some managers include debt that is directly sourced and originated and therefore less liquid, but carries more of a liquidity premium.

On the structured credit side, there's also a number of investments that are relatively common to multi-asset credit funds, ranging from residential mortgage-backed securities in the US, to covered bonds in the UK, or various other securitisations - credit card receivables, auto loan receivables.

Lastly, municipal bonds, even though they're typically thought of as a more tax-sensitive investment, there are certain higher yielding municipal bonds that might be appropriate for this type of product and could also provide good diversification benefits.

In terms of how a manager allocates to all those different sectors, they will certainly have some kind of framework, whether it's relying purely on a research team to identify their best ideas, regardless of sector, and then bring those together in the portfolio - although that's somewhat less common. Most managers will also include some type of top down overlay. That is looking at the relative value from the sector level, considering broader trends in the macro environment. A good example of that would be where central banks are in terms of hiking or lowering interest rates.

Finally, that relative value component can be short or long-term in nature, or it can be both, so a manager will generally have a means for coming up with a strategic asset allocation, which they will try to stick with in the long run, but make tactical adjustments as they go.

What are the potential risks in investing in multi-asset credit?

Within a multi-asset credit fund, where you're targeting a higher yield, an investor will need to accept some credit risk and the more credit risk that you accept, the higher the probability of default.

The best way to control the risk of default is to use a team of experienced credit research analysts and it's also to maintain conviction in your positions but not to let one position become so large that its risk of default dominates the entire portfolio. So again, that idea of diversification is very important when it comes to mitigating not only the overall volatility but credit risk.

The second risk that investors potentially face is duration risk. That's the risk that's associated with the fund's exposure to fluctuations in interest rates. This was actually one of the reasons we've seen so many unconstrained bond funds in the last several years. It was this idea that central banks around the world had been so low for so long that they would eventually be hiking, so taking more term risk wasn't going to be the answer to adding yield to your portfolio, since rising rates can be detrimental to longer-term bond allocations, so it was looking at these credit sectors that have less correlation to rates.

That being the case, most multi-asset credit funds tend to have a relatively low duration at least compared to, say, an investment grade credit benchmark.

What sort of qualities should investors look for in a multi-asset credit manager and how does Franklin Templeton stand out?

Investors, whether they be pension schemes or individuals, are in a great position, because multi-asset credit is popular, and that means the number of funds available is growing. We also talked about how seemingly no two funds are identical, so investors can look at their current portfolio, they can look at where they have standalone sector exposures. They can look at where they might have certain regional biases, and they can go back to multi-sector credit managers and basically look for the fund that gives them either more of the exposures that they want or conversely, gives them exposures that they don't have, but they are planning to build on a standalone basis.

Investors can also look at their liquidity profile. Then finally, and perhaps most importantly, what is their risk/reward expectation? Again, risk/reward and liquidity profile and sector profile will be almost always the drivers of selection of a multi-asset credit manager.

With regard to Franklin Templeton, and multi-asset credit investing, we believe we are very well placed. We have an extensive global fixed income platform with significant resources devoted to credit research, across multiple sectors around the world. We also have, for each of the underlying components of our multi-asset credit fund, a relatively long track record in managing those assets on a standalone basis.

In the unconstrained bond and multi-sector spaces we also have numerous funds, both regional and global, with long track records, so we have a framework in place, to make sure that teams from around the world are continually sharing their best ideas and that the relevant portfolio managers can collect those ideas and implement them in portfolios.