More than a half decade after the global financial crisis, the traditional mantra that one makes money in the stock market and keeps it in the bond market doesn't apply. The tectonic shift holds implications for institutional asset owners such as pensions, endowments and foundations.
“For our clientele, which are the large pension plans and endowments, traditional bond portfolios no longer make a meaningful contribution to meeting their liability demands,” said Philip Siller, co-CEO of Broadriver Asset Management, a provider of non-correlated fixed income alternatives for institutional investors. “For the past seven years, institutions have been booking gains as they ran off their bond portfolio or sold it, but those are market gains. Those aren't typical fixed-income gains.”
Once they’ve booked these gains, however, institutions are faced with the challenge of redeploying capital into a low-rate environment. The traditional method of dealing with this problem -- moving down on credit quality or increasing leverage -- may not be an option, as all-in rates on lower-quality instruments have fallen to the point where they no longer compensate for the increased risk.
As a consequence, asset managers are reassessing the need for marketability in their portfolios, and are turning to less traditional forms of credit such as short-term corporate receivables and municipal tax liens.
Philip Siller, Broadriver Asset Management
“When we talk to our clientele about it, something has to give, and what has to give is marketability,” said Siller. “As long as you're getting regular cash flow to meet your liabilities, marketability isn't so important, especially in a true crisis where your bond marketability is going to be as impaired as the marketability of any of your stocks.”
Just as private equity has been widely incorporated into the asset allocation of most institutional funds, so too will private credit strategies find their place among allocations in large diversified investment pools, Siller added.
Private credit strategies have several characteristics: high credit quality, reliable cash flow, low volatility, outsize yields reflective of inefficient asset pricing, and diversification from the capital markets.
“We are very interested in non-correlation, which is a reaction that everyone has had to the financial crisis,” said Siller. “The easy way to get higher yields is to take on more risks, but you could have always done that. You could have always bought junk bonds if you wanted a higher yield.”
One of the private credit strategies that Broadriver employs is short-term corporate receivables, which traditionally went directly to the commercial paper market, but now are constrained from doing so.
“The commercial paper market has really changed, post-financial crisis, and that market has in fact withered,” said Broadriver co-CEO Andrew Plevin. “Part of the desirability of going to the commercial paper market was that it got the assets off your balance sheet and helped improve returns on assets. That was challenged by the accounting profession.”
As a result, corporate receivables are being sold directly via trading venues such as The Receivables Exchange, an online marketplace for U.S. receivables sales, which has formed a strategic alliance with NYSE Euronext to market its Corporate Receivables Program to potential accounts receivable sellers, including NYSE-listed companies.
“Instead of going to commercial paper, corporations are now selling their high-grade receivables directly, and that's a really interesting market, especially for people who want short-term return,” said Plevin.
Another private credit strategy that Broadriver employs is “longevity assets,” whereby insurance companies essentially lay off their pools of longevity risk to institutional investors. Longevity assets provide high-quality credit, low volatility, and reliable cash flows at attention-grabbing yields.
“These are risks on life insurance, and there is an aftermarket for that,” said Siller. “Here we are generally looking at 10 to 12 year type durations. Our counterparties are investment grade life insurance carriers and the returns are in the low teens generally.”
Featured image via hywards/Dollar Photo Club
