Most clients coming from U.K., but global interest is on the rise
Global money managers are seeing constant — and in some cases increased — demand for buy-and-maintain credit strategies from across the globe, as lower liquidity, cost concerns and the flaws in both active and passive credit management creep higher up the agenda of institutional investors.
Executives at money management firms said while U.K. clients have largely been the lifeblood of buy-and-maintain strategies, the U.S. is becoming a new hunting ground for allocations to these benchmark-agnostic, low-turnover, investment-grade credit strategies.
“Interest is accelerating,” said Simon Males, head of global fixed-income distribution at Legal & General Investment Management in London. “We have a number of new buy-and-maintain investors from the euro region as well as U.S. dollar region - there is definite interest and execution.”
Mr. Males declined to name clients. LGIM runs £54.3 billion in buy-and-maintain strategies.
Andy Burgess, London-based fixed-income product specialist at Insight Investment, said the money manager has seen client inflows into segregated allocations principally from the U.K., although buy-and-maintain is becoming more popular in the U.S. and Asia. Insight also is seeing more popularity for its pooled buy-and-maintain strategy, which it launched in June 2013, and now has more than £1 billion ($1.5 billion) in assets. Overall, Insight has £17.2 billion in buy-and-maintain strategies.
Most commonly found as an alternative to actively or passively managed investment-grade credit portfolios, buy-and-maintain has benefited from the drawbacks of both these types of management strategies. Sources highlighted issues with forced selling in the case of passive investment, and the higher management fees associated with active management. They said investors can expect a five basis points to 10 basis points fee reduction vs. active management — about a 25% to 33% discount.
“We are not doing buy-and-maintain in fixed income, but I think it's interesting,” said an executive at a U.K. pension fund who requested anonymity. “It overcomes the liquidity issues in credit and, by buying less liquid or unusual bonds, some additional yield can be harvested. (That is) something we (as long-term investors) should get around to doing something about.”
Sources at money management firms said a typical buy-and-maintain portfolio will have turnover of about 10% per year. One source said his firm's active funds typically have up to 40% turnover per year, down from about 80% a few years ago when liquidity was less of a concern. He said even 40% is low turnover for an active strategy.
Recent moves
A number of high-profile U.K.-based pension funds recently have made the move to buy-and-maintain credit strategies:
nRPMI RailPen, the in-house manager for the £21 billion Railways Pension Scheme, London, moved its £625 million investment-grade bond portfolio to a buy-and-maintain credit strategy in November. Craig Heron, investment manager at RPMI RailPen, said in an interview at the time that executives want to hold a straightforward portfolio, do not want to be forced to sell or trade bonds — except in the case of significant downgrades of holdings — and expect to save 50 to 60 basis points by removing trading costs associated with the portfolio.
nSouth Yorkshire Pension Fund, Barnsley, England, appointed Royal London Asset Management to run a £250 million buy-and-maintain credit strategy, it announced in a filing in May. Executives at the £6.3 billion pension fund could not be reached for comment.
nEnvironment Agency Pension Fund, London, said in its latest annual report for the year ended March 31 that part of its bond allocation “has been refocused on a "buy-and-maintain' basis, giving us a low-cost portfolio with a better balance and more consideration of environmental, social and governance issues than an indexed allocation would achieve.” Executives at the £2.7 billion pension fund could not be reached for comment.
Overcoming strategy flaws
“Reflecting education and support with the consulting market, there has been significant increase in demand for buy-and-maintain credit, with (U.K.) investors typically looking to transition from passive mandates of sterling credit, to one or a combination of buy-and-maintain and multistrategy credit,” said Mr. Males.
Insight's Mr. Burgess said buy-and-maintain “has been popular for a while, but it is certainly getting more prominent now, and people are waking up to the flaws in passive investment.”
There are a number of problems with tracking a bond index, said sources. “There has always been criticism about fixed-income benchmarks, and active management can mitigate some of the inherent risks and biases,” said David Rae, London-based head of client strategy and research, and head of liability investment solutions at Russell Investments. “Buy-and-maintain is an extension of that, to take a cheaper approach.”
Risks for passive strategies include concentration. “A U.K. credit benchmark has about a 35% weighting to financials, and a relatively small number of companies makes up a large proportion of the index; by moving away from the benchmark you can create a portfolio which is better diversified, and you should expect better risk-adjusted returns over a market cycle,” said Joe Abrams, a researcher in consultant Mercer Ltd.'s fixed-income division, based in London. He said the firm has been encouraging clients to move toward buy-and-maintain credit for some time, and away from benchmark-relative active or passive strategies.
In avoiding benchmarks, buy-and-maintain “takes off that straitjacket,” said Shalin Shah, London-based credit fund manager at Royal London Asset Management. The strategy can also avoid forced selling, with portfolio managers able to make decisions on whether to hold onto a “fallen angel” bond that has been downgraded to subinvestment grade, allowing buy-and-maintain managers to capture inefficiencies in credit markets, he said.
The maturation of pension funds also has contributed to the popularity of buy-and-maintain. “Demand has come from a need to better match the liability portfolio in terms of duration, length of maturity of liabilities and cash flows,” said Mr. Shah. The majority of the £3 billion RLAM runs in buy-and-maintain invested assets or those under transition to buy-and-maintain are invested via segregated arrangements. But there is also demand for its pooled strategy, he said.
Mr. Burgess said Insight also has seen inflows from clients who have been very happy with Insight's active management performance, “but don't need that alpha generation anymore.”
A different set of rules
Despite reduced transaction costs, less concentration risk and a fee reduction vs. active strategies, Willis Towers Watson PLC is not convinced these elements are compelling enough to recommend the strategy to clients.
“We do see the merit in the basic thesis of avoiding transaction costs, but that, plus a modest fee discount, is not enough to overwhelmingly” put the consultant in buy-and-maintain's camp, said Chris Redmond, global head of credit at Willis Towers Watson, based in London. He highlighted concerns over forced selling in some cases; that these strategies might be “orphaned or forgotten about;” and difficulty in measuring success.
Managers and their clients therefore need to be smart about how they implement, run and monitor buy-and-maintain portfolios.
“Buy-and-maintain strategies are actively managed but the active decisions are more front-loaded, despite the ability to actively "maintain' the portfolio. One of the obvious drawbacks is accountability - if there is no benchmark, it is difficult to attribute performance,” said Mr. Abrams.
Therefore, a custom set of measurements are necessary for managers to demonstrate that they are adding value vs. other options, said sources. These might include comparing the default rates of holdings within a strategy against the broader credit market index, and tracking costs and turnover.
By Pensions & Investments
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