Category: DB

Broadening the universe: The strategic case for alternative credit

The falls over the past two years in high yield and emerging market debt (‘alternative credit’) credit spreads,1 along with indications of late-cycle behaviour in the US, has led some investors to be nervous about allocating to these areas. But should pension schemes reconsider?

Alternative credit has a number of attractive qualities including diversification benefits, a stable source of cash flow and returns in excess of expected defaults. While the current low level of credit spreads and the evidence of late cycle dynamics support being cautious, we do not feel this supports having a very low or zero allocation. For example, LGIM’s Diversified Fund, which targets achieving the most efficient way of accessing long-term investment returns, has a c.15% allocation to alternative credit. The ‘optimal allocation’ to alternative credit varies by investor but we believe alternative credit is an important constituent of the asset class universe and should form a meaningful part of most pension schemes' strategic asset allocation.

While we sympathise with investor caution over alternative credit at this point in economic cycle, we believe that many pension schemes are significantly underweight the asset class in their strategic asset allocations. In this article – one of a series on broad asset classes – we detail the strategic benefits of allocating to alternative credit and why we believe investing in the asset class could be beneficial for many schemes.

Diversification - the only free lunch in finance

For many institutional investors, the majority of their growth assets continue to be allocated to global equities. This leads their risk profiles to be dominated by equity risk. Alternative credit, along with other asset classes such as property and private market assets2, offer investors the opportunity to diversify their risk exposure and improve their risk-adjusted return profile.

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