By David van Bragt and Gertjan Medendorp, Aegon Asset Management
In recent years alternative fixed income assets such as mortgage loans, infrastructure financing and private debt have become much more important categories for institutional investors. They can provide opportunities to increase portfolio yield when the (often lower) liquidity of these assets is not a constraint. This is typically the case for long-term investors, such as pension funds and life insurance companies.
We show in this paper that alternative fixed income strategies demonstrate great variety, both in terms of spread, risk, capital charge, liquidity, duration matching and ESG factors. Investors thus have an opportunity to select those assets which best fit their particular investment needs, by taking the different characteristics of these assets into account. We compare different categories within the alternative fixed income spectrum in the table below. It is important to note that the scores on the different dimensions can (and will) shift over time and that the assessment is sometimes based on qualitive instead of quantitative measures (the ESG assessment being an example). Capital charges are determined with the standard formula of the Solvency II regulations.
Table 1: Characteristics of a variety of fixed income asset classes (for illustrative purposes only). Actual spreads are reported for strategies which are available via a well-diversified fund format. For more bespoke strategies a spread range is given. Rating indications in this table are either external ratings (when available) or internal ratings (for unrated instruments). We here consider the matching properties for an investor with long-term liabilities. More information about the ESG classification of the different strategies is given in the last column. We here use three labels (responsible, sustainable and impact), which are discussed in more detail below. Sources: Bloomberg, Aegon Asset Management, La Banque Postale Asset Management, Danske Bank, as of April 30, 2022 or latest available.
In the full paper, the different characteristics of each asset class in Table 1 are discussed in more detail.
The main conclusions of this paper are:
- The alternative fixed income asset class is highly diverse, embracing private debt, consumer loans, mortgage investments, insured loans, loans to small and medium-sized enterprises (SMEs), infrastructure debt and asset-backed securities (ABS). These assets can offer enhanced yields compared to government and corporate bonds, along with relatively low correlations to traditional assets.
- An alternative fixed income allocation can offer investors practical exposure to a wide variety of return drivers, many of which also have an environmental, social and governance (ESG) focus.
- Alternative fixed income is particularly attractive for long-term investors, including pension funds and life insurance companies.
- An interesting feature of many alternative fixed income assets are the additional safety measures compared to traditional corporate loans, such as covenants and guarantees.
- Alternative fixed income strategies exhibit great variety in terms of spread, risk, capital charge, liquidity, duration matching and ESG impact. This enables investors to choose those assets which best fit their particular investment needs, by taking the different characteristics of these assets into account.
