- 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.
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.
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).
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.
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.
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.
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).
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.