Tuesday, September 1, 2020 Stamford, CT USA — At a time of historically low interest rates and historically high levels of market volatility, growing numbers of institutional investors are finding short-duration credit strategies to be valuable tools in striking the difficult balance of risk and return.
“In the run up to the COVID-19 crisis, institutional investors were working to close troubling funding gaps—often by pushing fixed-income allocations into products providing greater yield and, with it, greater risks,” says Greenwich Associates Managing Director Davis Walmsley. “These moves left them exposed to a market correction and in need of portfolio liquidity amid an upsurge in volatility.”
From February to March 2020, Greenwich Associates, in partnership with Lord Abbett, interviewed 117 U.S. institutional investors about the challenges they face and changes they made to their portfolios to enhance returns while managing risk and liquidity. Prior to the start of the crisis, corporate pension funds participating in the study reported average funding ratios of 84%, while public pensions reported average funding levels of 70%.
Since then, institutional funding ratios have been affected by high levels of market volatility, a shuttering of the global economy and a further decline in interest rates that were already stuck at historically low levels. In this environment, institutions have one thing in common: the need to optimize yield on fixed-income assets at all points on the yield curve and risk spectrum.
According to Joseph Graham, Lord Abbett’s Investment Strategist, “The panic in March was another example of dramatic spread widening in short term, high quality bonds due to liquidity needs of investors. It also provided another example of the resiliency of these issuers and structures on the securitized side – proving again that short-term bonds generally bend, not break.”
A new Greenwich Report, Short Duration Credit: A Multifaceted Addition to the Fixed-Income Toolbox, presents the full results of the study and examines how institutions are using short-duration credit strategies to help achieve that goal.
Optimizing Risk, Return and Liquidity with Short-Duration Credit
Institutional investors are adding allocations to short-duration credit as a means of enhancing returns while preserving essential portfolio liquidity. Institutions in the study are using short duration credit in three primary ways: to optimize cash allocations, as a complement to core fixed-income allocations and as a diversification to credit.
The report points out that investment-grade-rated short-term bonds and structured products have a history of very low defaults and principal losses even in stressed times. Spreads widen in the short term due to liquidity needs, but over longer periods without losses, there is a powerful pull to par for short-dated maturities.
“While we have a lot of anecdotal conversations with our clients about managing liquidity and use cases for short duration, this study provided an opportunity to hear from a broader cross section of the institutional community- what their concerns are and how we might partner with them to provide solutions for today’s liquidity issues,” says Joseph Graham.