Opportunities in alternative fixed income


Opportunities in alternative fixed income

In recent years alternative fixed income assets such as mortgage loans, infrastructure financing and private debt have become much more important categories for institutional investors. They can provide opportunities to increase portfolio yield when the (often lower) liquidity of these assets is not a constraint. This is typically the case for long-term investors, such as pension funds and life insurance companies.

 

We show in this paper that alternative fixed income strategies demonstrate great variety, both in terms of spread, risk, capital charge, liquidity, duration matching and ESG factors. Investors thus have an opportunity to select those assets which best fit their particular investment needs, by taking the different characteristics of these assets into account. We compare different categories within the alternative fixed income spectrum in the table below. It is important to note that the scores on the different dimensions can (and will) shift over time and that the assessment is sometimes based on qualitive instead of quantitative measures (the ESG assessment being an example). Capital charges are determined with the standard formula of the Solvency II regulations.

 

Table 1: Comparing different alternative fixed income strategies

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Table 1: Characteristics of a variety of fixed income asset classes (for illustrative purposes only). Indicative spreads in EUR. Actual spreads are reported for strategies which are available via a well-diversified fund format. For more bespoke strategies a spread range is given. Rating indications in this table are either external ratings (when available) or internal ratings (for unrated instruments). We here consider the matching properties for an investor with long-term liabilities. For details on how the strategies can have an ESG angle, get in touch with us. Sources: Bloomberg, Aegon Asset Management, La Banque Postale Asset Management, as at September 30, 2022 or latest available.

 

In the full paper, the different characteristics of each asset class in Table 1 are discussed in more detail.

 

The main conclusions of this paper are:

 

  • In recent years alternative fixed income assets such as mortgage loans, infrastructure financing and private debt have become much more important categories for institutional investors. They can provide opportunities to increase portfolio yield when the (often lower) liquidity of these assets is not a constraint. This is typically the case for long-term investors, such as pension funds and life insurance companies.
  • Many insurance investors will already be aware of the benefits of Dutch mortgages, which can provide an attractive return on capital. Other types of alternative fixed income can add diversification alongside mortgages, but also alongside public market investments. Higher yields are possible (even with well-collateralized senior loans), particularly in private corporate debt markets..
  • In practice, an alternative fixed income allocation can offer exposure to a wide variety of return drivers, many of which also have an ESG focus. Examples discussed in this article include insured loans (either credits or trade finance), SME loans and infrastructure debt. An interesting feature of these categories is that greater safety measures can exist compared to traditional corporate loans, for example in the form of additional covenants or guarantees. Dutch SME loans can, for example, benefit from additional protection by the European Investment Fund, while private debt and trade finance can benefit from additional protection by an insurance company.
  • Alternative fixed income strategies demonstrate great variety, both in terms of spread, risk, capital charge, liquidity, duration matching and ESG factors. Investors have an opportunity to select those assets which best fit their particular investment needs, by taking the different characteristics of these assets into account.

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