Multi-Asset Credit

Michael C. Buchanan
Deputy Chief Investment Officer
Robert O. Abad
Product Specialist

Executive Summary

  • Our view is that credit is going to be an important part of an investor portfolio in the years ahead and active rotation across various sectors globally will remain vital.
  • The MAC strategy emphasizes income primarily and seeks to maximize total return within a mid-level volatility range of 5% to 7%, largely consistent with global unhedged bond volatility.
  • One of the key differentiators of the strategy is the inclusion of specific tail-risk protection strategies, which look to protect a client’s portfolio against significant drawdowns when credit markets come under pressure.

In this Q&A, Western Asset Deputy Chief Investment Officer Michael Buchanan and Product Specialist Robert Abad discuss the Western Asset Multi-Asset Credit (MAC) Strategy. Since its inception in 2010, this unconstrained strategy has sought to maximize income and expected total return within a specified risk budget by providing diversified exposures to higher-yielding asset classes globally. Michael and Robert also explain how tail-risk protection strategies are utilized in an effort to mitigate drawdown risk stemming from periods of high market volatility in the global credit markets.

Q: Why do you think MAC is relevant in today’s environment and going forward?

MB: Given absolute low levels of interest rates globally, there’s going to be a greater reliance on income to drive return. For the MAC strategy, a main component of this will be the use of credit sectors. In our view, credit is going to be an important part of an investor portfolio in the years ahead and active rotation across various sectors globally will remain vital. Credit sectors don’t necessarily move in tandem; they have different cycles, and they do well in different markets. The idea that you can tactically rotate from one to the other to find value and drive alpha is important.

It’s also important to acknowledge the difference between credit versus only corporate credit. MAC encompasses sectors beyond the corporate credits of high-yield, investment-grade and emerging markets. There is a host of other sectors out there that offer very compelling income, and risk-adjusted returns, such as agency and non-agency debt as well as residential and commercial mortgage-backed securities (MBS). To capitalize on this, we’ve built out our infrastructure and expertise in these sectors. The input we receive from these sector teams has been part of our broad market strategies for a long time.

Also, not being benchmarked or tethered to the low levels of benchmark rates will be important going forward. I say that because strategies that look to beat a benchmark inherently have to be conscious of tracking error, so managers may own sectors that they have to live with rather than what they possess conviction on. By measuring the performance of MAC through a Sharpe Ratio, we’re able to express our conviction ideas, but give a clear sense of how we’re performing on a risk-adjusted basis. We see MAC as an unconstrained strategy that can help investors navigate through different market environments.

Q: The term unconstrained is defined in the industry in a variety of ways; how does Western Asset define it?

RA: Throughout the industry, the term is used to describe various strategies that are managed without a benchmark or are targeting a total rate of return. Generally, the strategies will have broad guidelines and very different risk profiles. At Western Asset, we define unconstrained investing as strategies with no benchmark to guide our portfolio construction. We generally segment our unconstrained suite of products by target risk level, asset types and the source of the risk budget—normally macro or spread products. This allows us to bring multiple solutions to meet different clients’ desired risk and return profiles. On one end of the spectrum are strategies such as our Total Return Unconstrained strategy, which targets bond-like volatilities (3% to 5%) and moderate returns. This strategy tends to have a longer-term investment bias and generally make gradual changes to allocations. On the other end of the spectrum are strategies such as our Macro Opportunities strategy, which targets a higher level of volatility (8% to 10%) and larger returns. This strategy provides more concentrated and opportunistic exposures to Western Asset’s main themes, and may make frequent and/or significant allocation shifts.

Our MAC strategy primarily emphasizes income and seeks to maximize total return within a mid-level volatility range of 5% to 7%, which is largely consistent with global unhedged bond volatility. The strategy’s investable universe spans the whole global fixed-income spectrum: investment-grade and high-yield corporate bonds, non-dollar debt, bank loans, emerging market debt and structured securities. Unlike other multi-sector products that may have a bias toward a particular sector or geography, our MAC strategy has no sector, regional or credit quality biases. One of the key differentiators of the strategy is the inclusion of specific tail-risk protection strategies, which look to protect a client’s portfolio against significant drawdowns when credit markets come under pressure. These tail-risk strategies may include taking long duration positions in government bonds, utilizing derivatives on credit indices or equity indices to remove credit risk or implementing option strategies that look to provide a hedge in the case of certain negative events.

Q: What kind of tail risk protection are you currently employing?

MB: One of the key features of MAC is that it has to work in a risk-off environment. The avoidance of drawdown can be a real help over the longer term. You also want to be careful not to expose the client to basis risk, where the correlations of those hedges to the core portfolios are not that strong. By that, I mean you have a big risk-off period and you don’t get the desired benefit from your tail hedging. For now, you’ll see us employ more high-yield-related tail-risk hedges given the extent of our high-yield positions at this time. This will be on top of our use of currencies, rates and equity options as additional ways to use hedges. We’re always looking to use the most cost efficient hedges that are available.

One recent example of how we employ tail-risk protection is our experience during the Brexit referendum. Our call was that Remain would win out and that we would see a bit of a risk rally after the vote. To ensure that we had some protection against a risk-off environment following a Brexit outcome, we worked with our Macro Team to have some currency and duration offsets in place. Our Derivatives Team also put some option strategies in place, specifically, puts and put spreads on the S&P 500 and high-yield credit default swap indices, as additional tail-risk protection. As we all know, Brexit prevailed. While the impact across global markets was significant, MAC portfolios were able to navigate through this period of market turbulence without sacrificing performance.

Q: Given that each unconstrained strategy has different volatility aims, how does that impact the investment decision-making process?

MB: Our investment decision-making process remains the same. We have the philosophy of looking for long-term fundamental value along with the use of diversification. For MAC, our risk budget of 5% to 7% provides the ability to find this value across sectors. With that said, we don’t limit ourselves to sectors that have the volatility attributes of the ultimate portfolio. We can use low volatility sectors that can act as a good offset to higher volatility sectors. A significant risk budget also gives us license, when we identify greater relative value opportunities, to go into higher volatility sectors such as high-yield or local emerging markets, or other sectors where we think the illiquidity premium can be exploited through our own fundamental work. We recognize there’s a liquidity tradeoff, and that’s obviously something we budget for as we construct our portfolios. The key is to maintain a proper balance between liquid and illiquid positions. The value-add that I believe we bring here is the analysis we perform to actually assess the volatility of these positions. In this aspect, it’s crucial that we combine the research of our analysts with our risk management capabilities. The analysts will look at the strength of the security while our risk team will look at the security’s place from a more holistic point of view. As the lead Portfolio Manager, I ultimately decide how the securities fit together with respect to the volatility target.

Q: How does your experience in credit help with a strategy like this?

MB: Corporate credit, throughout its history, has been one of the bigger income-generating sectors. Having someone who has a long history in this space is important with a strategy such as MAC. If you’re a capable portfolio manager in the credit space, it means that you’ve learned how to use your resources and your research intelligence to draw on those insights and put them together in a comprehensive and cohesive portfolio format that makes sense. It’s not necessarily about being a portfolio manager that knows everything about every industry and company, but it is important that you know the general drivers of what makes a good credit investment, for example, a strong management team.

Q: How do you integrate the top-down and bottom-up views into the process?

MB: It’s important to know how to speak the language of the analysts, while allowing them to be the experts within their industries. The job as I see it is to put all of this together in a way that makes sense for what we’re trying to achieve. I’ve always believed that deep research talent is vital to delivering outperformance in credit. We need people who really know how to dig in. I’ve seen enough of credit cycles, my fair share of good and bad companies to know attributes that should make a company successful. With that said, the analysts also need to bring their expertise to the forefront. I bring a top-down view to the process, and work with analysts who are thinking about their own respective industries and companies from a bottom-up perspective. In combination, I think this makes for a strong investment process overall.

Q: Given your deep background in credit, how do you avoid bias?

MB: Western Asset’s Unconstrained Asset Allocation Committee has senior representation from each credit sector, as well as generalist participation from Ken Leech, our CIO and lead Portfolio Manager of our Macro Opportunities strategy, and Mark Lindbloom, the lead Portfolio Manager of our Total Return Unconstrained strategy. It’s in that forum where we look at fundamentals for each one of those asset classes, as well as sector valuations and technicals to reach our top-down views on value.

Ultimately, we use that collective insight to drive toward an allocation decision. Because we have representation from the various asset classes and generalist contributions, those biases tend to be filtered. Also, the portfolio management structure of MAC itself, which includes me as lead Portfolio Manager and Ken and Mark as generalist Portfolio Managers, provides a good system of checks and balances.

Q: What are the competitive advantages that Western Asset has in regards to this strategy?

RA: As global markets expand and more countries and corporations throughout the world issue bonds, the global bond market and the potential opportunities expand with it. As a firm emphasizing global breadth and local depth, Western Asset is well situated to take advantage of these changes and reflect them throughout our diversified suite of unconstrained products, including MAC. Western Asset has over 40 years of fixed-income experience with a global platform that spans seven investment offices across five continents. As Michael noted earlier, the Firm has specialized sector teams including Global Investment-Grade and High-Yield Credit, Structured Products (Agency MBS, Non-Agency MBS and ABS), Inflation-Linked, Long Duration/LDI, Liquidity Management, Insurance, Sovereign, Emerging Market Debt and US Municipal Securities. This depth of global fixed-income coverage and resources enables us to feel confident that we can find appropriate investment opportunities.

This paper was originally posted August 2015.

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