The present direction of the market and capital deployment trends are a minefield of shifting demands, said Peter Ehret, Director of Internal Credit at the Employees’ Retirement System of Texas.
In a recent Clear Path Analysis report, “Institutional Fixed Income, North America 2022”, several senior industry players – including Ehret – spoke about the trends in the market and what challenges and opportunities they were seeing.
“We are in a waiting period – a waiting period for things to get worse in the real economy,” said Ehret when asked about these trends. “We focus on markets and the first thing, of course, to be upset by inflation and rate increases is the market. That gets our attention.”
“We are waiting for that second part of actual harm to the real economy to
get underway, which we believe is happening now.”
He said this effect leads to underlying investment consequences for fixed income managers such as credit distress and default – but that it also isn’t the whole issue. “That takes problems in the economy,” he said. “So, we are waiting for that second part of actual harm to the real economy to get underway, which we believe is happening now.”
Ehret added that there has been a lot of pain so far in the market for those in fixed income, which is the first part of this issue. “We saw 13.5% off for high yield [in 2022], and it is a lot worse for the riskier parts of the market. We’re down 16% for CCCs, but it only leaves spreads at 500 basis points. But that’s without an economic slowdown or recession.”
“While we still see a bumpy road ahead, investors can lock in yields that
haven’t been this high in years.”
This ‘pain’, however, could see some easing. A January 2023 report from asset manager Vanguard saw growth over this year after a rocky 2022. “For 2023, we see a transition from pain to gain. While we still see a bumpy road ahead, investors can lock in yields that haven’t been this high in years. More stability in interest rates and clarity on monetary policy should bring flows back into fixed income,” they said in their report, “Active Fixed Income Perspectives Q1 2023: From pain to gain”.
The questions also took precedence in a 2022 investor survey by State Street Global Advisors, which said that investors had at least 20% of their fixed income portfolios allocated to index strategies. Panellists at the event were asked if this is a cost-effective strategy and whether it will become more prevalent in 2023.
“In terms of cost-effectiveness, for making shorter term moves, especially in a market like this where you might want to play things in a more short-term way, [putting it into index strategies] is a cost-effective method,” said Ehret. He added it was an easier process to put money into an index than it was to find the same level of liquidity in individual bond investment line items such as in the high yield markets.
“That being said, over time, it locks in an expense drag and so this is the loser fee that we don’t care to pay over time, but in the short term for moving things around, yes.”
“One thinks of indexes as being expansive and that they cover the universe, but
they don’t. We are more careful when it comes to index products.”
Ehret said that a less pressing – but still persistent – problem with index strategies is that they miss a big part of the market. “One thinks of indexes as perhaps being very expansive and that they cover the universe, but they don’t,” he said. He gave the example of a high yield situation, which tended to be more liquid bonds. “In these indexes it will be a bit bigger cap, with higher quality and there is a lot of market that the indexes doesn’t touch,” he said.
“For these reasons we are more careful and are more tactical and short term when it comes to index products,” he said.
