1.11.2017 21

Amundi Pension Funds Letter n°3

Published November 1, 2017

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Shifting approaches from yield spectrum to credit continuum

In their everlasting search for yield, pension funds have broadened and deepened their exposure to credit since the end of the financial crisis and shifted to a pro-active approach to balance funding risk with a strategic asset allocation. But in order to capture other types of returns beyond the traditional bond universe risk premia, it is necessary to push the limits or cross investment boundaries, be they theoretical, legal or accounting.

While the means of geographical diversification and lower ratings have compensated part of the yield reduction, pressure pushed investors to explore the credit continuum even further. Credit universe proves to be deep enough in terms of sub-asset classes and market segmentation to offer investor yield pick-up as well as diversification potential, but if earnings from credit continuum have a moderate risk profile, entering and going further in the credit continuum comes with slightly higher risk tolerance. While 2018 is approaching as a year of transition, it’s probably time to reconfirm or not the benefits of such an approach.

Firstly, risky asset markets do deserve consideration in the current environment, which is characterized by 1) a more mature cycle, mild inflation and better growth macro fundamentals, 2) positive dynamics of corporates, including leverage stabilization, and 3) orderly standardization of monetary policies by Central Banks.

Secondly, risky asset strategies should offer resilience to long-term investors, whether considering country spread, issuer or debt structure. Priority should be given to quality of issuers, security selection with a focus on liquidity in order to capture alpha opportunities.

The European macro environment continued to improve with positive headlines supportive for credit benign technical factors, ECB accommodative policy, and an expected subdued primary market. The normalization process with rising rates is also expected to be smooth, the well communicated exit from stimulus programmes being anticipated to only generate short-term credit volatility.

Developed Markets corporate bonds fundamentals remain relatively stable both in the US and Europe. Emerging Market Debt (EMD) should increasingly be considered as a “carry trade” and a diversification story, the room for spread compression going forward being tight. EM countries’ improved balance-sheet quality and financial stability conditions are positive. The asset class is still favored by investors’ flows. This overall context is supportive of a Credit Continuum strategy as: “A credit continuum strategy aims to meet the end goal of investors looking for attractive yields by tapping opportunities across the credit spectrum with a focus on cash-flow generating”.

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