March 2021 / INVESTMENT INSIGHTS
Expanding the Liquid Fixed Income Toolkit
Using credit in asset allocation
Key Insights
- As an asset class, fixed income is a mainstay of institutional portfolios. It offers investors a natural hedge against future liabilities, as well as generating returns and acting as a diversifier for other asset classes held in the portfolio.
- A multi-decade decline in interest rates has brought some of these objectives into conflict and falling yields have put pension fund and insurance company funding models under pressure.
- In present value terms, in 1999, a payment of £100 to be made 30 years in the future had a present value of just £26. By mid-2020 that had risen to £83.
- Many investors are turning to the private debt markets, such as real estate, infrastructure and corporate loans, to generate the required cash flow.
- Private debt markets are less transparent and less liquid than public markets, and they can create an increased governance burden for trustees.
- We believe investors building cashflow-matching focused portfolios should consider more liquid, less widely used fixed income sectors such as Asia credit, emerging market (EM) corporate debt and globally diversified high yield debt.
- We’ll discuss how these sectors can offer relatively attractive and predictable cash flows in the medium term, enabling investors to generate extra income without compromising on liquidity and transparency.
Fixed income and the funding conundrum
Fixed income plays multiple roles in the portfolios of institutional investors such as pension funds and insurance companies. The returns and cash flows from fixed income have the benefit of being relatively predictable, especially if bonds are held to maturity. Investors measure their future
liabilities using the yields available on high- quality fixed income instruments, making bonds and other fixed income assets a natural hedge against changes in the current value of those liabilities.
But the two-decade structural decline in high- quality bond yields, compounded by lower central bank policy rates and quantitative easing, has reduced yields at all maturities, both in nominal and in real terms.
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March 2021 / PODCAST
March 2021 / INVESTMENT INSIGHTS
Drew Armstrong is an assistant vice president of T. Rowe Price Associates, Inc. and a solutions analyst for the multi-asset solutions team in the Multi-Asset Division. As a member of the multi-asset solutions team, he works closely with the portfolio management, quantitative and trading teams to expand and refine the firm's liability-driven investing capabilities. Drew joined T. Rowe Price in 2013 as an investment fellow and completed the program's rotational assignments in Portfolio Modeling, Fixed Income Solutions and Investment Risk Management prior to his current role. He earned a B.S. in mathematical sciences from Carnegie Mellon University in Pittsburgh, Pennsylvania.