Financial product innovations seem to follow a pattern these days: move from traditional, index-linked regionally focused strategies towards globally focused solutions. Today, innovation is about applying a broad toolkit and global investment parameters in order to meet return objectives that may no longer be comparable with traditional benchmarks. This is particularly true in the fixed income space, where new solutions tend to be benchmark agnostic, use quantitative tools and incorporate a global investment paradigm with allocations across asset classes and market segments.
Canadian pension investors are now dealing with the challenges of the current risk and return environment, including low nominal and real sovereign yields, and a deficient funded status for some. Others, on the other hand, may enjoy fully funded status yet find immunization unattractive at current levels. A host of fixed income strategies have emerged in response to the challenges plan sponsors are facing. Unconstrained and sector specific, absolute return fixed income strategies seek to offer investors a desired return stream while demonstrating a core bond-like volatility profile, without the undue influence of a market beta emanating from a traditional benchmark index.
Broaden the spectrum
For investors willing to move further along the return spectrum, fixed income can be used as backing for long equity positions in smart betas achieved through index-linked instruments. This includes strategies such as fundamentally weighted equity indices, as well as long-short equity market neutral strategies where the excess capital is invested in an actively managed bond portfolio for investors looking to reduce equity beta risk but not to exit equities entirely. Fixed income strategies can also be used to fund a 100 per cent long equity position, plus a tail-risk hedging program (through the purchase of put options, for example), for investors who are less concerned with alpha generation and more concerned with limiting losses to the downside after several years of upward-trending developed equity markets.
Plan sponsors are also asking questions about derivative overlay programs (the buying and selling of financial instruments on interest rates) as a potential way to hedge liabilities for pension investors while investing a portion of the remaining capital in a liquid collateral portfolio.
Andrew Spottiswoode is vice-president, product manager, PIMCO.