KEY TAKEAWAYS

  • MAC is an unconstrained strategy (not tied to a benchmark) that appeals to investors due to its diversification and return potential.
  • The strategy is customizable to approximate a range of risk levels as it seeks to capture the income and return potential offered by credit markets worldwide.
  • MAC can help fulfill investors’ need for diversified strategies and the ability to provide active sector rotation to drive alpha as part of a diversified portfolio.
  • The primary drivers of MAC’s success include its proven ability to provide high income, daily liquidity, flexible sector rotation and duration management and downside protection.

Finding an attractive source of income remains a challenge for individual investors, pension funds and institutions globally. The challenge stems from both the myriad investment opportunities now available, as well as the inherent complexities surrounding asset allocation, market timing and risk management. As we enter 2020 facing new risks and opportunities, we wanted to provide investors with an overview of the characteristics and merits of Western Asset’s Multi-Asset Credit (MAC) strategy.

MAC Landscape

Investors have gravitated toward MAC solutions in recent years not only because of their diversification and return potential, but also because investors increasingly value the expertise of an experienced manager to make allocation decisions (i.e., active sector rotation) across global credit. That stated, investors need to be very mindful of the type of MAC strategy they select, as the product landscape encompasses offerings with differing investment opportunity sets, return targets and risk profiles. Education on each strategy is critical to help compare and contrast the merits of one MAC strategy versus another.

In general, there are three types of MAC solutions across the product landscape. They range from:

  • Conservative: These strategies target returns at the lower end of the MAC spectrum; they have minimal duration flexibility and focus more on higher quality, investment-grade-rated assets.
  • Traditional: This is the “sweet spot” in the MAC product landscape; these strategies have a broader opportunity set that focuses more on publicly traded credit markets.
  • Aggressive: These strategies are “higher octane”; they use more illiquid asset classes such as private credit, real estate or distressed debt in an effort to generate higher returns.
Exhibit 1: The MAC Product Landscape
Explore the MAC product landscape.
Source: Western Asset. Select the image to expand the view.

Note that the trade-offs of pursuing higher returns center around taking on increased volatility, drawdown risk, and/or illiquidity risk. To better navigate the MAC landscape, we would encourage investors to look for an asset manager such as Western Asset, which has the size and global scale to identify and source investment opportunities, has time-tested experience investing across all forms of credit and has a solid long-term track record managing MAC-specific mandates.

MAC at Western Asset

At Western Asset, MAC is an unconstrained (i.e., non-benchmark aware) strategy that seeks to capture the income and return potential offered by credit markets worldwide. Our program looks for value opportunities across corporate credit within the traditional high-yield (HY) and investment-grade (IG) space and a host of other spread sectors that offer the potential for compelling income and risk-adjusted returns, such as residential and commercial mortgage-backed securities (MBS), agency and non-agency debt, emerging market (EM) debt, bank loans and collateralized loan obligations (CLOs).

Because there is no benchmark by which to measure MAC performance, we look at the returns relative to actual volatility. Looking at MAC through the lens of risk-adjusted performance (Exhibit 2), we believe our Sharpe Ratio of 1.35 since 2010—the inception of our MAC strategy—is a strong testament to Western Asset’s investment and risk management capabilities.

We have always emphasized two points to our MAC clients: the need for diversified strategies so that no single strategy dominates portfolio returns, and the importance of active sector rotation (i.e., emphasizing one sector while de-emphasizing another) to drive alpha in a diversified portfolio. This investment philosophy has served us well during both strong risk-on and risk-off markets over the years as illustrated by MAC’s attractive risk and return profile relative to single-name asset classes (Exhibit 2).

Exhibit 2: MAC—Performance and Risk Statistics
Source: (A) Western Asset. As of 31 Dec 19, (B) Bloomberg Barclays, J.P. Morgan, Western Asset. As of 31 Dec 19. Past performance is not indicative of future results. Select the image to expand the view.
1The Multi-Asset Credit Composite is not measured against a benchmark. There is no benchmark available which appropriately reflects the strategy.
2Performance shown is gross of fees. Returns for periods greater than one year are annualized. Please see the Performance Disclosure for more information.
3Incepted 01 Oct 10.
US Investment Grade is represented by Bloomberg Barclays U.S. Credit Corporate Index, US High Yield is represented by Bloomberg Barclays U.S. High Yield Index, USD Emerging Markets is represented by JPM Emerging Markets Bond Index Plus (EMBI+), EM Corporates is represented by JPM CEMBI Broad Index, US Aggregate is represented by Bloomberg Barclays U.S. Aggregate Index. The information provided is supplemental to the Multi-Asset Credit Composite.

Drivers of MAC Success

MAC’s success can be attributed to Western Asset’s Investment and Risk Management Teams’ focus and discipline on four basic parameters: (1) high income, (2) daily liquidity, (3) flexibility and (4) downside protection.

1. An emphasis on high income
Unlike other strategies that look to generate high total return by going into more illiquid asset classes, using esoteric derivatives and/or employing leverage—in effect, exposing investors to more drawdown, volatility and liquidity risk—MAC is primarily focused on identifying cash-based securities that offer high current income. Ultimately, it is active sector rotation in MAC—the ability to shift to those sectors and subsectors where we see the most compelling risk-adjusted returns—which is the main engine driving income and return generation. Patience in sticking to our high-conviction calls during difficult market cycles such as 2015 and 2018 has also been a key contributor to MAC’s success.

Exhibit 3 shows MAC returns for each calendar year, the contribution to return by each risk factor and annualized return since inception. The data underscores the fact that MAC’s returns come from a variety of sources (e.g., corporate bonds, structured credit, EM, etc.) which is to be expected given the strategy’s investment objective. It is also a testament to our portfolio construction process, which emphasizes a diversified strategies approach to mitigate the risk of any one strategy dominating longterm portfolio returns.

Exhibit 3: MAC—Return Contribution Since Inception
Explore MAC—Return Contribution Since Inception
Source: Western Asset. As of 31 Dec 19. Select the image to expand the view.
1Per annum (%). Inception of strategy was 01 Oct 10.
2Includes EM corporate bonds.
3All currency activity.
Note: categories were selected to be consistent with the risk management categories.

In our view, heavily barbelled approaches in credit strategies (i.e., having an equally high concentration to low and high beta asset classes) are vulnerable in “taper tantrum”-type scenarios where both spread sectors and government bonds sell off in tandem. Holding a concentrated segment of one market in a MAC strategy for an extended period of time (simply because it may be a core strength for a particular manager) misses the point on diversification and can be a losing proposition if that particular market segment falls out of favor or experiences a tail-risk event. Exhibit 4 highlights the extent of our dynamic sector rotation program and the broad range of sector allocations in our MAC strategy since its inception.

Exhibit 4: MAC—Demonstrated Active Sector Rotation Over Time and Sector Allocation Ranges
Explore Demonstrated Active Sector Rotation Over Time and Sector Allocation Ranges
Source: Western Asset. As of 31 Dec 19. Select the image to expand the view.

2. An emphasis on daily liquidity
Our MAC Investment Team, in conjunction with our risk colleagues, continually seeks the best risk-reward opportunities, all the while looking to use our liquidity budget wisely. Depending on prevailing market conditions and valuations, we will invest opportunistically in sectors such as CLOs and whole loans (i.e., when we believe we are receiving sufficient incremental yield for the illiquidity risk), but we work to avoid having outsized exposures to illiquid securities or asset classes. This emphasis on daily liquidity may be compelling for investors who have concerns about the strategy’s ability to meet redemptions during challenging market conditions.

3. An emphasis on flexibility
The MAC strategy incorporates a volatility (or risk) budget of 5% to 7%, which allows our Investment Team sufficient latitude to seek value across global credit markets, while simultaneously acting as a key risk-control factor. Historically, portfolio volatility has been closer to 4%, reflecting the decline in broad market volatility post-crisis and the Investment Team’s discipline in not going lower in credit quality for the sake of yield.
The strategy also has the flexibility to adjust portfolio duration from 0 to 10 years (Exhibit 5). In our view, while there will always be an ideological debate over the use of duration in MAC strategies or what might be the most effective hedge for a broad fixed-income portfolio, tactical duration positioning in a credit-orientated strategy has strong merit. We favor US Treasuries as a hedging tool to protect MAC portfolios against broad market volatility on the view that the low correlation between US government bonds and risk assets will persist.

Exhibit 5: MAC—Duration Positioning by Sector
Source: Western Asset. As of 31 Dec 19. Select the image to expand the view. *Other includes Municipals, Local Authorities, Supra-nationals, Equity, Cash/Cash Equivalents

4. An emphasis on downside protection
The MAC strategy also offer investors a unique (and optional) risk management feature: tail-risk hedging. Historically, these hedges have comprised exchange-traded derivatives on equity or credit market indices or an allocation to developed market currencies (e.g., the Japanese yen). Our strong preference is to use option strategies on the S&P 500 Index given their low cost and their meaningful correlation to higher beta segments of the fixed-income market (e.g., US high-yield) during periods of market turbulence.

We would emphasize that our tail-risk hedging program is a complement to our tactical duration positioning. Tail-risk hedges are intended to act as an additional “shock absorber” against sudden and unforeseen downside market shocks (e.g., a 2008 crisis event). They are not intended as a hedge against all portfolio downside risk—the costs associated with such an exercise would be exorbitantly expensive for any portfolio.
As noted in Exhibit 3, our tail-risk hedges have not only been additive to portfolio returns since inception (as opposed to detracting from performance due to the cost of purchasing protection), they have also helped to smooth overall portfolio volatility (even if they do not appear to add value in specific years).

In Closing

While finding an attractive source of income can be challenging to investors in today’s low-yield world, we believe that Western Asset’s MAC strategy may be a viable solution for all the reasons discussed here. As investment managers offering both global breadth and local depth, we believe that Western Asset is well situated to exploit the growing opportunities in credit markets for the benefit of our clients.

View the Performance and Risk Disclosure for Multi-Asset Credit.