How are investors responding to the prospect of rising rates? Here’s a look at plan sponsors’ reactions and some potential enhancements to the fixed income structure.
Public funds, endowments, foundations, and Taft-Hartley plans have all steadily reduced their allocations to fixed income; the one exception, corporate funds, has been increasing fixed income exposure because of liability-driven investing concerns. This means that many plans are increasing the risk in their portfolios.
At the same time they are seeking additional juice for the fixed income portfolio to combat the prevailing low-return environment. To date, they have primarily invested in spread products but are now examining non-traditional solutions that may confer a liquidity premium. These may include private credit as well as multi-sector credit strategies, which can dynamically shift exposures based on market opportunities.
Current spreads across investment-grade credit, high-yield bonds, bank loans, and emerging market debt are in line with long-term historical averages, but the challenge for plan sponsors is that those spreads are based off of extremely low returns for cash. And while many plan sponsors have moved into spread products, this increases the correlation of their fixed income allocation with the equity piece of their portfolios.
For sponsors that have already aggressively re-risked their portfolios, these non-traditional alternatives may not be suitable. But for plans with a higher level of fixed income, such strategies merit serious consideration.