Asset owners discuss debt mandate flexibility

Allowing changes in fixed income mandates can enable investors to cope better with rising interest rates, widening credit spreads and falling prices, said participants at a recent roundtable, as they discussed portfolio positioning.

With expectations that government bond yields will rise and credit spreads will widen as the US tapers its stimulus programme, Stephen Thariyan, global head of credit at Henderson Global Investors, urged flexibility in bond investment guidelines.

“These mandates can be versus a traditional index or absolute- or total return-oriented,” he noted. “I think you just have to be a little bit savvier, a little bit more global and a little bit more flexible.”

But changing mandate guidelines is not always easy, as it means explaining to the investment committee why managers are being allowed more freedom, said Heman Wong, executive director of Hong Kong's $6.7 billion Hospital Authority Provident Fund Scheme (HAPFS).

“There has to be good justification to buy, for example, a B-rated bond. I’d be willing to look at it, but obviously I would not welcome a new request every day,” he added.

Still, HAPFS has made certain portfolio changes, such as shifting some bond exposure into alternative investments to reduce duration risk and enhance returns. This involved allocating to a fund of hedge funds and to global real estate investment trusts 12 months ago.

But Wong's investment committee members have been notably cautious about shifting some of the bond allocation to an absolute fixed-income strategy, because it involved short-selling. “We spent close to two months discussing and reviewing the investment guidelines line by line to ensure we were not taking on excessive risk,” he said.

He had to explain that the strategy would not involve short-selling physical bonds of an illiquid nature and that therefore there would be no potential short squeeze.

Hong Kong-based conglomerate Jardine Matheson allows a high degree of guideline flexibility, said Adrian Teng, group treasurer of the firm, which runs defined-benefit and defined-contribution pension plans across the UK, Hong Kong and Indonesia.

“We set the benchmark, but it’s a customised benchmark, and we tend to be quite agnostic as to whether the managers move away from it,” he noted. “We give the PMs good latitude to react to market changes – that’s the whole point of active management.” 

However, there are things that raise doubts for some institutional investors – use of derivatives being one.

“Some are quite comfortable with derivatives, while some will say ‘absolutely not, nothing that sounds like derivatives, not even for hedging, because it’s always for speculation’”, said Adeline Tan head of investment advisory at Mercer Investments Hong Kong.

Thariyan agreed that the mention of derivatives to some investors in Asia had resulted in them starting to “turn green”. But such instruments have an important role to play in efficient portfolio management, he noted, such as for hedging.

Reluctance to embrace greater mandate flexibility in Asia can be partly attributed to pension funds not having built up their investment expertise and sophistication as quickly as they have amassed sizeable assets, Wong noted.