How a Multi-Asset Credit Approach Can Outperform Traditional Fixed-Income Portfolios

In the years ahead, investors will need to navigate shifting markets – and prepare for the inevitability of rising rates. Many are wondering how they can enhance their portfolios to generate incremental returns on a risk-adjusted basis. This often involves looking at new tools and a wider variety of assets. As a result, strategies such as multi-asset credit (MAC) have gained popularity.

Strategic allocations allow investors to capture a fair amount of return opportunities over a multiyear period. And while they’ve produced fair outcomes in recent years, we believe strategic allocations alone won’t be sufficient going forward. Fixed income spectrum returns are nonlinear and more volatile than most people would expect, and relative value is constantly changing across asset classes and regions. Broadening the exposure to a much wider universe of credit instruments can give portfolios more potential for outperformance.

MAC allows for dynamically identifying relatively undervalued assets on a consistent basis. An investor can apply a multi-asset allocation and tilt his or her portfolio toward areas that provide the best opportunities and capture incremental returns. The aim is to provide high-yield returns with less than high-yield risk.

The reason for MAC’s distinctive performance pattern, including the potential for both increased return and reduced risk, arises in part from the diversifying nature of the strategy. As opposed to traditional fixed income, MAC, as its name implies, can incorporate many different credit asset classes. The precise mix depends on the manager.

Managers and institutions approach multi-asset credit differently depending on their needs or capabilities. But most of these allocations encompass components of US leveraged finance – that is, high yield, bank loans, and collateralized loan debt obligations (CLOs). Then, to varying degrees, a MAC allocation can extend across geographies and the risk spectrum to include European leveraged finance, investment grade assets, and emerging markets debt.

To determine how to allocate within a multi-asset fixed income approach, asset managers must analyze and understand current market dynamics and how they could change in the future. Key to this is understanding what’s driving the relationships between asset classes and market volatility.

For example, monthly high yield fund flows have swung widely within a year, going from large negative outflows of tens of billions to positive. So in a short time, markets can shift from an oversold recessionary scenario to one that’s more risk-seeking in nature. This may prompt investors to consider increasing their high yield exposures when technical outflows result in highly attractive valuations and then subsequently reducing those exposures as the market reaches fair-value levels.

We believe investors that employ a MAC manager are better equipped to make quick allocation shifts between credit assets – and are less likely to miss investment opportunities – than investors that use a different manager for each type of credit asset. So while MAC can help investors position for the challenging environment ahead, it’s important that the strategy is paired with the right management.