Credit downgrades could be challenging for pension schemeswritten by Bella Palmer
More than £0.77trn of corporate issues have been downgraded, leading to short supply of high-quality assets
A falling average quality of fixed income indices combined with intensifying competition for high-quality assets could make it more challenging and costly for UK pension funds using benchmarks.
More than £0.77trn of corporate issues have been downgraded since the start of Covid-19, AXA Investment Managers said, leaving high-quality assets in short supply while demand is rising.
Over the last two years, high-profile issues including General Electric, Heathrow (Class A), HSBC (subordinated) and Wells Fargo (subordinated) have been downgraded and quit high-quality sterling indices, buy and maintain credit portfolio manager Simon Baxter noted.
Now, the top ten issuers make up more than 32% of the 15-plus-year index market value, while half of the index is comprised of just 21 issuers.
AXA IM warned that passive investors and the broader UK pension fund industry now faced a "difficult environment" while navigating large fixed income index rebalancings as issuers are downgraded.
The ultra-low interest rate environment since 2015 has provided corporate treasurers with a strong incentive to increase the overall level of indebtedness in capital structures, Baxter commented. This has resulted in a drop in the average credit quality of issuers, driving a large increase in the BBB component of credit indices, which now averages around 50% of the main credit indices.
Credit downgrades have largely been issuer- and sector-specific, he noted, but overall higher-quality sectors, such as housing associations, are now representing an increasingly large percentage of the longer-dated sterling credit indices. Noting the correlation within the industry and the ratings linkage with the UK sovereign, he said this could be a worrying trend.
Baxter said, for the UK pension fund industry, which is particularly reliant on the higher quality, 10-plus-year and 15-plus-year A to AAA indices, this presents a serious challenge and comes at a time when there is increasing demand for high-quality long-dated assets.
Plans are increasingly putting cashflow-generating solutions in place, and there are more investors chasing less available, high-quality assets. The ability to source these rare assets, at the right price, remains key to achieving portfolio goals, he said.
Investors passively following a benchmark approach may find the market increasingly concentrated, challenging, and costly to navigate, he concluded.
This article is for information purposes only.
Please remember that financial investments may rise or fall and past performance does not guarantee future performance in respect of income or capital growth; you may not get back the amount you invested.
There is no obligation to purchase anything but, if you decide to do so, you are strongly advised to consult a professional adviser before making any investment decisions.