Institutional investors show hunger for alternative credit

Increasing challenges to achieving fixed-income objectives have prompted a shift toward risk

Institutional investors show hunger for alternative credit
As central banks around the world slowly withdraw policy support and raise interest rates, fixed-income experts are seeing a path to global economic recovery — but it’s a challenging one that encourages more risk-taking.

In its first-ever Global Fixed Income Study, which surveyed 79 fixed-income specialists and CIOs across North America, EMEA, and Asia-Pacific, Invesco found that 58% of respondents see a strengthening global economic outlook. Two thirds agreed that central banks will shift from quantitative easing to tightening over the next three years.

There’s also a rough consensus that the yield curve will flatten. Sixty-eight per cent of respondents believed that the short end of the yield curve will rise in the next three years, while only 43% agreed (and 29% disagreed) that the long end will climb. Meanwhile, the objectives of fixed-income investment remained fundamentally consistent: portfolio risk reduction, capital preservation, and income generation.

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“With the objectives of fixed income being little changed despite the unconventional fixed-income environment, the task of achieving those objectives has become significantly more difficult,” the report said.

The study also found strong demand for alternative credit such as bank loans and real-estate debt. On average, respondents said 19% of their fixed-income portfolios have been allocated to alternative credit strategies, with North American investors having the most aggressive proportions at 26%. Investors with AUM topping US$15 billion tended to have higher allocations to alternative credit. Defined-benefit pension funds were also more adventurous in taking on alternative credit as they try to match the cash flows of their liabilities.

However, the allocations to alternative credit are expected to slow down as they face higher prices and a reduced set of opportunities; 63% of those polled said they expect to rotate back toward core fixed income over the next three years.

Notably, allocations toward emerging-market debt are expected to rise. While average allocations are at 3% currently, 29% of respondents anticipated that they will increase allocations over the next three years. Investors expect that improving economic fundamentals, shrinking current-account deficits and lesser direct impact of rising US interest rates will uncover opportunities.

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