Multi-asset study: multi-asset credit funds

Sarah Lochlund explores what role multi-asset credit (MAC) funds can play for institutional investors going forward.

Our 2023 multi-asset survey evaluated how well multi-asset growth funds navigated the difficult market backdrop of 2022. That report demonstrated that many funds avoided the magnitude of losses seen on traditional equity and bond investments over 2022, but it also raised several questions.

Most notably, the report questioned the size of many investors’ allocation to these funds and emphasised the importance of selecting a fund with characteristics aligned with the role the fund needed to play.

With that in mind, we now turn our attention to multi-asset credit (MAC) funds. Unlike a multi-asset growth fund, MAC funds focus on credit assets, aiming to generate returns through dynamic asset allocation and underlying credit selection across a wide range of fixed income instruments.

With yields now at higher levels, these funds are becoming a larger part of institutional investors’ portfolios, so it is worth exploring what we can learn from the journey investors have already been on with multi-asset growth funds and how this relates to MAC funds. How do we ensure that the funds selected match the role they are selected for? 

Past performance

As with the multi-asset growth funds, the turbulent market environment of 2022 provided a useful environment for testing these funds, and allowed investors an insight into their nature. Despite their more restricted investment universe, 2022 revealed a reasonable degree of variation in fund style and, by extension, fund performance.

(As a reminder, 2022 saw almost all asset classes lose value. In the credit universe, the most significant losses were seen in UK government bond indices – with conventional gilts returning -24% and index-linked gilts returning -34%)

As you might expect given the dramatic market backdrop, the strongest driver of performance over 2022 was the funds’ sensitivity to interest rates, the top performers being those with the lowest sensitivities to the rising yields and the worst performers those with the highest sensitivity.

All managers have some scope to adjust the fund’s sensitivity to interest rates, so how much of 2022's performance was the result of managers’ active decisions on interest rate positioning, and how much is a long-standing state that simply reflects the nature of the fund? 

We found that:

• Some of the best performing funds over 2022 made very little change to their exposures to interest rate movements over the period; they started low and kept them low. Perhaps more interestingly, the managers that started the year with a relatively high exposure to rates did not make dramatic moves either; in fact, many increased their sensitivity over the period.
• In practice, a manager’s scope to adjust the fund’s sensitivity to interest rates varies significantly from fund to fund. These restrictions can help and hinder – some managers may have wanted to reduce exposure to rising rates but the fund parameters wouldn't have permitted that; there may have been others who would have wanted to increase exposure but were limited by the prescribed range. 2022’s top performers were ahead of the pack because of the intrinsic characteristics of the fund; not because of active manager decisions in this area.
• Over a 3-year period, there was more variation in the funds’ sensitivities to interest rate movements, but most funds had maintained a ‘default’ level and there was a reasonable amount of variation in what that level was. This reflects the fact that MAC funds have very different permitted ranges (e.g., 0-3 years, -3 to +3 years, 0-6 years, etc.).

Performance vs credit risk

The correlation between performance and credit risk over 2022 was weak, which seems surprising out of context, but is more understandable once you overlay the somewhat unusual market conditions of 2022 and 2023, where assets that have long-been considered amongst the least risky have suffered the most significant losses and the highest volatility (i.e. gilts).

Over longer periods, whilst the top performing fund was also the fund with the lowest average credit rating (and vice versa), there was a broad range – especially amongst the riskier funds - where there was a spread of 5% per annum between the top and bottom performing fund.

Dynamic asset allocation

For many institutional clients, the driver for including a multi-asset credit fund in their portfolio is to gain exposure to a wider range of credit markets, and to benefit from an expert that will monitor and actively manage the allocation to each asset class as their market outlook changes. 

The dramatic change in the market backdrop of the last three years allows us to assess whether managers are providing this for clients. For example, the chart below shows that, on average, there has been an almost 20% swing in the funds’ allocation to investment-grade (IG) corporate bonds (from minimum to maximum) over this period. At the end of the September 2023, most managers were sitting at the top end of their historical range. This is in line with our outlook for credit and it's pleasing to see the managers using their ability to move asset allocations in this way, and to see them taking advantage of the ability to generate sufficient yield with less risk.

Conclusion

Returning to the questions we posed at the start, what can we learn from the journey investors have been on with multi-asset growth funds, and how do we ensure that the MAC funds match the role they are selected for? 

• Whilst managers may be dynamic with the high-level asset class allocation, there will be some characteristics that are intrinsic to the manager and the fund – most importantly the interest rate sensitivity and the level of credit risk. Don’t expect this to change dramatically even if the market backdrop does. 
• A fund’s sensitivity to interest rates will impact performance. Whilst the managers will alter the sensitivity to an extent, they centre around ‘default’ levels, and these default levels vary significantly between funds. Since January 2022, the funds’ interest rate sensitivity has been a dominating driver, drowning out many other factors. Going forward we do not expect a repeat of the rapid rises in rates, or volatility to return to its 2022 highs. However, we do expect volatility will remain higher than many institutional investors are used to and so the funds’ interest rate sensitivity will play a larger role in the performance of these funds. As an investor, this means you should be more proactive in deciding what the right ‘default’ level is in the context of your broader portfolio.
• Most of the funds we analysed have made good use of their ability to be dynamic with their asset allocation, but with mixed success. However, beyond the funds’ sensitivities to interest rates, we found no significant trends in individual performance drivers over 2022, or indeed over longer periods. This suggests that it would not be easy to replicate performance with a static portfolio. 

Finally, what should investors be looking out for when selecting a MAC?

1. Select a fund that has the right parameters for the job you need it to do. Especially regarding interest rate sensitivity, credit risk and the ability to move between asset classes. 
2. Select a manager that has empirical evidence of success running that type of fund.
3. Acknowledge that this is a strategy that is reliant on manager skill. 
4. Spend time selecting and monitoring managers, and make sure you have the risk tolerance to withstand the potential downside.

If you have any questions, your usual BW contact will be able to guide you through how to apply this to your portfolio, supported by our team of credit experts.