Can multi-asset credit improve DC performance?
Multi-asset credit has played a growing role in defined benefit schemes for some years, although it still forms a very small part – if any – of most defined contribution (DC) allocations. We consider the merits of adding MAC to the mix for DC schemes by illustrating a range of portfolios in the 10-years leading to retirement.
Most DC lifestyles start with riskier assets, mainly equities, and gradually de-risk over time, often into diversified growth funds (DGFs) to target a desired retirement outcome. MAC does not typically feature, which raises the question: “Can exposure to MAC improve outcomes?”
What is MAC?
Multi-asset credit, or ‘MAC’, funds typically span the spectrum of credit asset classes and are characterised by their flexibility to allocate dynamically, rather than having fixed allocations. MAC funds come in many forms but in our examples we have included high yield bonds, bank loans, structured credit, cocos, convertible bonds and emerging market debt.
MAC versus DGF
DGFs also come in many shapes and sizes and are a popular inclusion in DC funds. They invest across a wide range of assets and the prime attraction is the expectation of equity-like returns with lower volatility. An example asset allocation might be:
|Investment grade bonds||15%|
|Absolute return assets||10%|
Modelling the performance of DGFs is not straightforward, given the variety of approaches. In the table below, we have selected a range of popular/large funds and averaged their performance.
Performance & volatility comparison over 10 years
|10-year return||10-year volatility|
Overall returns are similar, with MAC slightly ahead. In risk terms, MAC exhibits around 80% of the volatility of DGFs.
The merits of MAC
We introduced MAC allocations into three DC lifestyles to see how it impacted performance.
Profile 1: Cash lifestyle
This profile is a glidepath with a retirement mix of 70% cash and 30% DGFs. Substituting half the DGF exposure for MAC (15%) improves results by lowering risk without sacrificing returns.
Profile 2: Drawdown lifestyle
This profile is a glidepath with a retirement mix of 30% cash and 70% DGF. Substituting half the DGF exposure for MAC (35%) makes a notable difference in risk reduction. Returns are also higher with the addition of MAC and over the 10-year period, the pot size would be a GBP2,900 increase, based on a GBP100,000 starting portfolio.
Profile 3: Annuity lifestyle
Our final example considers a retirement exposure that includes 50% sterling Gilts and bonds at retirement, alongside 30% DGFs and 20% cash. Substituting half the DGF allocation with a 15% exposure to MAC again proves beneficial, making more difference in the early years when the exposure is higher. Based on a GBP100,000 starting pension pot, adding MAC improves the outcome by GBP2,300 over the 10-year period.
Across our three scenarios, adding MAC to the DC mix had a positive impact, with MAC contributing from both a risk and risk standpoint. One key attraction of MAC funds, in our view, is that the underlying assets are largely ‘contractual cashflows’, payable as long as a bond issuer does not default. This contrasts with equities, which can form a large component of DGFs, where equity dividends are not contractual.
For some time, MAC has been a popular choice for defined benefit funds, notably playing a role as pension funds have de-risked out of equities but do not want to sacrifice returns. In our view, MAC can play the same role for DC schemes, reducing volatility without necessarily reducing returns.
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