Jerry Song, Institutional Strategy & Analytics, J.P. Morgan Asset Management
Bob Cast, UK DC Client Advisor Alex Dryden, Investment Specialist
DC plans should consider adding multi-asset credit strategies to their default strategies
An allocation to multi-asset credit can bring default portfolios more in line with the needs of today’s plan members, who are increasingly looking for options to stay invested up to and through retirement. Particularly in the mid phase of the glide path, plan members may be missing out on access to the attractive returns, diversification and downside protection that a multi-asset credit strategy can provide.
A MORE APPROPRIATE GLIDE PATH
A typical Defined Contribution (DC) default strategy begins to diversify away from equities in the mid phase of the glide path using diversified growth funds (DGFs), and by the late phase can be invested only in gilts and cash.
The blue line in the chart below shows the expected volatility and returns for a typical default allocation across the glide path, while the purple line shows the traditional allocations over time for DC plan members who choose a drawdown option at retirement.
The green line shows how risk-adjusted returns can potentially be improved by introducing a multi-asset credit allocation starting in the mid phase of the glidepath, which could be more appropriate for the needs of today’s DC plan members.
EXHIBIT 1: ADDING MULTI-ASSET CREDIT SHIFTS A MEMBER’S EFFICIENT FRONTIER
Source: J.P Morgan Asset Management, Long-Term Capital Market Assumptions as of 31 March 2020. Covariance estimates are based on historical monthly or quarterly returns from Q3 2006 to Q2 2019, depending on the reporting frequency of the underlying asset. For illustrative purposes only.
THREE WAYS THAT DC PLANS CAN BENEFIT FROM CREDIT EXPOSURE
Unconstrained credit makes DC fixed income allocations work harder
Multi-asset credit funds use flexible sector allocations (top-down) and rigorous security selection (bottom-up) to capture attractive returns with less volatility than the highest beta credit and fixed income sectors.
When considering the monetary policy backdrop, interest rates are likely to stay lower for even longer. In this environment, duration is unlikely to be a major contributor to overall returns for the foreseeable future. Instead, we see the credit risk premium and active sector and security selection playing an increasingly important role in driving performance.
The ability of flexible multi-asset credit funds to dynamically shift corporate credit allocations and interest rate sensitivity throughout the market cycle can help DC plans to improve the overall risk-adjusted return profile of their default strategy.
EXHIBIT 2: SECTOR AND DURATION POSITIONING IS ACTIVELY MANAGED THROUGH THE MARKET CYCLE
Source: J.P Morgan Asset Management. For illustrative purposes only.
Dynamic credit can capitalise on more alpha opportunities while limiting risk
An unconstrained approach gives managers the freedom to express their views. If they do not like a sector or a name, they don’t own it. This flexibility enables managers to react quickly to risk events and take advantage of opportunities across the full corporate credit universe as they arise.
Although managers have the freedom to invest in their favoured segments of the market, all of this can be conducted within a robust risk management framework that ensures risk is managed within pre-defined limits.
Diversified credit exposure can produce a smoother investment journey for DC members
Diversification plays a key role in producing attractive risk adjusted returns. This can be achieved by accessing a truly global opportunity set, including both developed and emerging markets, allocating across different asset classes and taking exposure to a wide range of companies and sectors with varying business models. The below chart shows the protection that this diversified approach can have in protecting on the downside by limiting the overall drawdown of the investment journey.
EXHIBIT 3: MULTI-ASSET CREDIT HAS DEMONSTRATED A LOWER DRAWDOWN PROFILE THAN OTHER ASSET CLASSES
Source: J.P. Morgan Asset Management, Bloomberg. All rights reserved. Data as of 31 June 2020. Multi-Asset Credit = J.P Morgan Multi-Sector Fund I (acc) USD Hedged. U.S High Yield = Bloomberg Barclays US Corporate High Yield Total Return Index, EM USD = Bloomberg Barclays EM USD Aggregate: Corporate, Global IG = Bloomberg Barclays Global Aggregate Corporate Total Return Index Hedged USD. US equities = S&P 500.