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SS&C Intralinks®

2021 DCM Investor Survey What’s Ahead for the Debt Capital Markets?

Produced in association with

Editor’s note Patricia Gatmaitan

We are pleased to present the SS&C Intralinks 2021 DCM Investor Survey, produced in association with Institutional Asset Manager. In this debut edition, we set out to understand investors’ plans concerning their debt portfolios for the coming year. As markets sway and uncertainty continues to reign, we surveyed a diverse group of 106 investors active in the debt capital markets (DCM) from across the globe. The aim was to understand their outlook, concerns and factors influencing their sentiment and decision-making process around debt instruments over the next 12 months. The respondents were a mix of institutional investors, asset managers, family offices and investment banks. Nearly half were C-level executives. Broadly speaking, we learned that investors have faith in debt capital markets even in these turbulent times. As a potential debt default

Director, Product Marketing, Banking & Securities

cycle looms on the horizon, those hungry for yield will be seeking opportunities, provided they are highly discerning and have the appropriate risk appetite. We hope these insights will prove useful as you navigate your business through the challenges of a fast-changing post-pandemic environment.

Executive summary

Survey methodology

Preparing for the storm

Caution up ahead

Page 3

Page 4

Page 6

Page 10

Muted returns

Importance of relationships

Shift into private assets

Technology and the market

Page 12

Page 13

Page 14

Page 16

Monitoring and control

Opportunity in crisis

Conclusion

Page 19

Page 20

Page 23 2

Executive summary Fixed income remains a preferred asset

Outside of their portfolios, investors

class among institutional investors. This

are most concerned about financial

is evidenced by the fact that the majority

risk, cybercrime and credit issues.

of investors in the survey either increased

These considerations are reflected in

or maintained their allocation to debt over

their call for better tools for reporting

the past three years.

and compliance.

The debt portion of institutional

Most investors are encouraged by the

portfolios appears to be the least

technology employed by banks/issuers

negatively impacted by the pandemic.

in DCM transactions. They cite being

Only 15 percent of investors decreased

able to communicate efficiently with

their allocation in reaction to this

issuers and viewing deal documents

unprecedented event. This is low,

quickly and securely as key to the

considering 34 percent reduced their

transaction process.

equity holdings. Investors’ primary use of debt instruments is in plain vanilla bonds. Asset-backed securities and private debt round out the top three sub-asset classes of choice.

Survey methodology

The survey canvassed the opinions of 106 investors.

Latin America

Asia-Pacific

Respondents by geography DCM investors from around the globe participated in the survey.

5 Europe, the Middle East and Africa

Types of investors surveyed

Family Office Portfolio Manager/Asset Manager Wealth Manager Institutional Investor Pension Fund Insurance Company Endowment/Foundation Other Financial Institution

The survey captured the sentiment of a range of professionals engaged in the debt capital markets.

Survey methodology Which of the following best describes your role?

26%

18%

16%

13%

12%

11%

Chief Investment Officer

Investment Team Member (Portfolio Manager, Analyst, Strategist)

Director/ Executive Director

Investment Officer

CEO

Other

CFO/ Treasury

Preparing for the storm Amid pandemic woes and political uncertainty, different

Carmalt, managing director, head of debt capital markets

sectors of the debt capital markets have experienced

at Lloyds Banking Group.

mixed fortunes. Of the various asset classes in the space, some have demonstrated resilience in the turmoil while others have struggled. Corporate debt issuance rose throughout 2020 as companies sought to secure capital to see them through the COVID-19 crisis. This meant investors had the opportunity to invest in investment-grade debt at attractive valuations, and thus deployed their capital. On the other hand, issuance in the U.S. leveraged loan

With regards to “snapping wider,” Carmalt expects less liquidity in debt capital markets. Over a quarter of investors (26 percent) confirmed that they had increased their allocation to fixed income within the past three years. The majority (57 percent), however, registered no change in allocation, though this does not preclude changes within the fixed income portfolio itself. On average, debt investments account for 16 percent of institutional investor portfolios (Charts 1 and 2).

market lagged, recovering only in the third quarter of Chart 1. What percentage of your portfolio is currently allocated to DCM assets?

2020. However, total issuance in the space remains muted with year-to-date institutional volumes at 10-year lows.1 The U.S. institutional leveraged loan default rate is expected to increase to 3 percent in 2020.

DCM Assets

16%

100%

Chart 2. How has your alloction to debt capital markets changed in the past three years?

“Many borrowers are being hyper prudent and prefinancing what is needed in late 2020 and into 2021. There is a far greater risk of the market snapping wider rather than continuing to tighten. This is why we’re seeing issuers take advantage of what are very constructive markets ahead of the latter stages of the year,” comments David

60% 40% 20%

17%

57%

Decreased

No Change

26%

0% Increased

[1] As of September 2020, S&P Global Ratings [2] Fitch Ratings

The broad fixed income category also appears to have

“In general, investors have done three things. First, they

been resilient among the investors surveyed. Fixed

have taken on more risk by investing in riskier asset

income has been one of the least negatively affected

types. Second, they have increased the complexity of

asset classes in terms of portfolio allocation. Only 15

the instruments they’re using. So rather than reach for

percent decreased their fixed income holdings, whereas

sub-investment grade bonds they’ve chosen things like

34 percent lowered their equity investments over the

collateralized securities to help generate returns. And third,

same period (Chart 3).

in support of both of these changes, institutional investors

John Nugée, an independent consultant and lecturer, with an extensive background in advising official

are increasingly engaging professional asset managers either to manage their funds or to advise them.”

institutions, outlines how the behavior of institutional

According to the investors polled, the most prevalent

investors across the industry has changed concerning

debt investment vehicles in use are plain vanilla bonds (50

debt instruments.

percent), asset-backed securities (33 percent) and debt private placements (31 percent). Read on for further detail on the appeal of private debt.

Chart 3. How have your allocation expectations been affected by the events of the COVID-19 pandemic? 80% 60% 40% 20% 0% Equities (domestic & developed)

Fixed income (domestic & developed)

Affected - increased allocation

Emerging market debt

Emerging market equity

Affected - decreased allocation

Alternatives

Cash

Not affected - same expected allocation

Although Nugée speaks of a shift to collateralized assets,

The mix of asset classes currently held in investor

the intended move may not have fully materialized across

portfolios is helping to mitigate their broader concerns

the whole asset-backed spectrum yet. Collateralized debt

around debt markets. The survey shows that their top

obligations (CDOs), collateralized loan obligations (CLOs),

concerns are financial risk (83 percent), business risk

and commercial mortgage-backed securities (CMBS) are

(82 percent) and credit issues (79 percent; Chart 5).

preferred by 13 percent, 16 percent, and 21 percent of the sampled investors, respectively (Chart 4).

Chart 4. Which of the following DCM asset classes do you invest in? 60%

50%

40%

30%

20%

10%

r he

lo ed as tb se As

ed fin an ba Com ce ck m ed er se cia cu l m rit o i e r tg s( a CM g e BS ) Le ve ra ge dl oa ns Co l l ob at lig er a at liz io e ns d l (C oa LO n s) Co lla te ra liz ed de bt

ts en iva

pr bt De

i ti

Chart 5. How concerned are you about the following in relation to DCM?

Very concerned and concerned

ea sc sin ru g r ti n e g y o ula f b to an r y ks

rc be Cy

e r im

PR ce Pri ss va t b y to i e v s tr n fo . p ad rm u b in g d a ti l i c es on ks

su is it ed Cr

k is lr ra te lla

na Fi

at er Op

G e m ove en r na t q nc ua e/ lit y

k is nc

na io

es sin Bu

90% 80% 70% 60% 50% 40% 30% 20% 10% 0%

Not very concerned and not concerned

“I think we’re going to enter a period where we are

Although some professional investors are battening down

going to see quite a lot of pain and defaults,” comments

the hatches, not all are ready to weather the storm. In the

Wayne Fitzgibbon, partner, Mercer, a global investment

view of Jason Kennedy, CEO, Kennedy Group, “People are

consultancy. “Most institutional investors I know expect

not listening to the noise around them so the markets and

this to happen and are being quite clever by getting ready

returns will continue along their current path. There will

for it. The upcoming default cycle could be really big and

be a chain reaction at some point, but I don’t know when

more significant than what we saw in 2008-09. But any

that will be because it should have happened already.”

crisis provides opportunities, especially given it is coming after a period in which it has been very difficult to sort the wheat from the chaff in terms of debt. As a result,

This sentiment likely suggests the market may witness a sudden series of defaults.

we’ve seen a lot of interest in things like fallen angel and distressed debt strategies.”

Caution up ahead Debt issuance in 2020 was significant in some parts

Mark Hedges, chief investment officer, Nationwide

of the market. For example, the amount of global debt

Pension Fund, comments: “We’re seeing opportunity

from financial and non-financial corporates rated

persisting in some of the ABS markets. Credit risk

by S&P Global Ratings grew by 6 percent between

transfer trades in the U.S. are one example, as are the

January 2019 and April 2020 to USD 20.6 trillion. By

cases where you’ve seen ratings migration.”

mid-2020, total capital raised in the corporate bond market neared USD 6.4 trillion and is likely to reach record highs at year-end.

Whichever their area of interest, investors should exert caution. Fitzgibbon says, “There has been very questionable issuance that some people have snapped up

In terms of the debt securitization markets, certain

because it seems attractively priced. The flood of capital

areas struggled more than others. For example, the

raising seen in recent months is attractive to investors,

U.S. CMBS market witnessed significant defaults

but they need to have the recognition that some of these

through 2020, quite close to the levels in 2013.3

companies could go under.”

Consumer asset-backed securities (ABS) fared

Brandon Laughren, co-founder and CIO of the Laughren

better. For example, for auto ABS, defaults are lower

Group, a single-family office, says, “At this moment, the

than anticipated, and this segment is expected to

only place I’m happy to increase allocations is in more

account for more than half of the $170 billion 2020

esoteric, capacity-constrained, physical asset-backed

full-year projection for US ABS4. Student loan ABS

investments like domestic shipping container leasing and

saw moderately active issuance, as underwriting

inland barge leasing, with managers we already know.

standards appear to have remained high.5 Credit card

These strategies offer high relative yields and are vital to

ABS was muted, though market analysts warn that

the movement of food, oil and basic goods.”

performance may start to be negatively impacted as forbearance programs end.

Pensioenfonds Detailhandel (BPFD), the pension fund for the retail sector in the Netherlands, has a considerably

[3] Fitch Ratings [4] S&P Global Ratings [5] Federated Hermes

larger fixed income portfolio than the average investor

already undertaken this process within our equity portfolio

included in the survey. Henk Groot, head of investments

and want to replicate it in the credit space.”

at BPFD, says, “We have a very simple portfolio with 60 percent of the total EUR 30 billion in fixed income, 30 percent in equities. We also have 10 percent in real estate and Dutch mortgages.”

The ESG concept is something Jeffrey Glenn, senior vice president, co-head of portfolio management at Breckinridge Capital Advisors, believes will provide opportunity: “The rising popularity of green bonds confirms

Groot does not envision any major changes to the fund’s

the growing enthusiasm among corporations to fund

broad asset allocation and few shifts within fixed income

meaningful sustainability efforts through the capital

sectors as well in 2021: “We invest in triple-A euro

markets. From an investor perspective, both green and

government bonds and there will be no changes to that

social bonds expand the opportunity set of securities

policy. There will also be no change in our high-yield or

funding long-term environmental and social benefits.”

emerging market debt exposure.”

According to Nugée, although investors are making some

The fund is exploring the potential of inflation-linked

moves within fixed income asset classes, the leap is usually

bonds, in light of the macroeconomic outlook, but no

one which remains close to home: “Everybody is trying

decision has been made. Groot comments: “I don’t

to expand what they do, but it usually starts from where

foresee us adding inflation-linked bonds to our portfolio

they are. No one is going to leap from their traditional

in the short-term, but it is a discussion we are having as

investment space into substantially different investments.

inflation is something which is of high interest to us.”

“Changes in allocations depend on the investor and the

A change the fund is planning to make is the integration

degree to which they are able to take on new ideas. Where

of ESG into its non-sovereign credit portfolio. Groot

they’re coming from also has an impact. For example,

notes: “This is not something that will change our

investors in Denmark have a long tradition of investing

allocation, but we will shift the way we construct our

in covered bonds. They understand this market and will

portfolio to integrate our focus on the United Nations’

therefore be willing to look at those outside Denmark.”

Sustainable Development Goals (SDGs) into it. We have

Muted returns On average, institutional investor return expectations

fixed income side. We expect 4 percent over the medium-

for debt capital markets the coming year are positive,

term or maybe a little more. Emerging market equities

averaging at 7 percent.

could return around 4.5 percent or more.”

Over the long-term, investors, on average, anticipate

In Carmalt’s view, the continued compression in yields

generating a return of 9 percent (See Chart 6).

can make it difficult to be compensated for differential risk. “One return challenge for bond investors is in the

Chart 6. What are your return expectations for your/ your organization’s DCM allocations for…

concertina-ing of spreads, which makes differentiating between credit quality based on yield even more difficult. For example, in the European covered bond

10% 5%

market, a number of years ago you would have been 7%

2021

Over the long-term

Funds like the BPFD sit at the more conservative end of this spectrum with medium-term expectations for global high yield at 3.5 percent. Groot says the anticipated return for local currency emerging market debt is much lower at 0.5 percent and EU bonds even have a negative outlook over the

paid a reasonable premium for certain jurisdictions over more defensive ones. Now, with ECB buying programs and the official liquidity that has been pumped into the market, that spread differential has been compressed significantly.” This essentially means investors may not be being adequately compensated for holding riskier assets like Spanish bonds instead of German instruments, for instance.

medium-term. Asked how this compares to equities, Groot comments: “We are still looking at equities more favorably and the returns look to be higher than on the

The growing importance of relationships Investor concerns currently center around COVID-19 (90

crisis, the uptick in regulation has meant intermediaries in

percent), the U.S. political climate (88 percent) and trade

the market can no longer hold large books of bonds.

relations (87 percent). Together with these pressures,

“Before the crisis, debt markets were very transactional,”

industry commentators recognize the deep structural

he points out, “when you wanted to buy you found someone

change which has occurred in debt markets (Chart 7).

to sell and vice versa. In the last few years, however, debt

Fitzgibbon notes: “Until 2007, corporate debt markets and

markets trade by appointment.

even high-yield markets were remarkably liquid. There was

“Relationships matter a lot more because you cannot just

a lot of transparency in pricing and everyone knew when

go to the market and expect the market to provide a bid for

something was trading, largely due to the fact that many

any asset you wish to sell.”

investment banks were active market makers holding bond inventories. ”Nugée says that following the global financial

Chart 7. How concerned are you about each of the following?

id ov /C

vir

re al Gl

-19

OR IB

io ss ce

ra In

po ry ta ne Mo

s te

lic

ns tio la re de Tr a

pr it ex Br

lit

90% 80% 70% 60% 50% 40% 30% 20% 10% 0%

Very concerned and concerned

Not very concerned and not concerned

Hunt for yield buoys shift into private assets As they hunt for ways to generate returns, institutional investors are turning to private debt. Private credit funds are considered significantly attractive as 42 percent of investments registered increases here in the past three years (Chart 8).

Chart 9. We are participating more in private placement/ direct lending transactions versus public securities 70% 60% 50% 40%

Chart 8. How has your/your organization’s investment in private credit funds changed in the past three years?

30% 20% 10% 0%

50% 25%

26%

17%

57%

0% Increased

Decreased

Agree

Strongly agree

Agree + strongly agree

Strongly disagree

Disagree

No change

“Investors seem to forget that there are many strategies Kennedy remarks, “I am definitely seeing a shift into

in private credit, not just those focused on financing

private assets and even private loans as we try to avoid

sponsor-backed transactions (the largest part of the

the big banks and get things done on the quiet where there

investable private credit market by dollar volume). It is

is a greater profit margin. I’m seeing this happening more

vital to remember that if you are investing in private credit

in Asia although it is now filtering through to Europe and

to diversify your overall portfolio, strategies that relate to

the United States.”

sponsor-backed transactions only magnify your exposure

Other institutional investors we surveyed support this

to private equity as an asset class.”

view as 60 percent agree or strongly agree they are

In Nugée’s opinion, “Private debt is offering yield — the big

participating more in private placement/direct lending

trade-off with private investments is yield for liquidity.

transactions versus public securities (Chart 9). From

Although some private investments are secure and well-

his perspective, Laughren warns that in the current

constructed deals, there is no doubt that as an asset

environment investors should not assume that private

class, it is considerably less liquid. This will appeal to

credit strategies will perform as they have in the past.

some investors and not to others.” 14

Some pension funds can tolerate this illiquidity, in return for a premium, as it can help them meet their long-term capital preservation and return objectives. Central banks and official institutions, like some sovereign wealth funds or development banks, on the other hand, are at the other end of the spectrum and cannot trade in their access to liquidity.

Chart 10. Do you agree or disagree with the following statements about leveraged loans? The pace of growth in the leveraged loan market was too fast after the 2008 financial crisis Strongly agree

22%

100%

Agree

46%

100%

Disagree

32%

100%

Although the BPFD does not plan to add significant allocations to private debt, Groot explains how the fund considers the asset class from an ESG perspective: “We

More leveraged lending opportunities will emerge as a result of COVID-19 Strongly agree

18%

100%

Agree

61%

100%

very small allocation.”

Disagree

18%

100%

Groot adds that leveraged loans are not on the fund’s list

Strongly disagree

2.88%

100%

have an interest in impact investing which is where we look at the private debt solutions available in the market and consider whether they fit our ESG criteria. But it’s a

of asset classes and are not considered for investment. This is reflected in the survey which found respondents

They’re definitely not going to get into direct loans.

did not profess much interest in leveraged loans, although

Rather, they would like to buy something which has

the outlook for the asset class is positive. A fifth of

somebody else’s seal of approval; a package or creation.

investors (22 percent) are concerned about the pace of

There’s a great deal of comfort for an investor to have

growth within the leveraged loan space, but 18 percent

a leading market operator making sure all is in line and

think more leverage lending opportunities will emerge as

whom they can hold accountable.”

a result of COVID-19 (Chart 10).

This can be evidenced in the growth of outsourcing by

Outlining the way pension funds and other institutional

pension funds and other institutional investors. For

investors may access leveraged loans, Nugée says:

example, Hedges says, “We have done particularly well

“Pension funds value the involvement of other people.

in a multi-asset structured credit fund. Rather than 15

picking one particular area, we gave one fund manager

Technology supports the market

a mandate to look at all the various pockets of ABS and search for relative value between CMBS, CLOs, etc., across different points in the credit structure at different times. This generated a solid

Industry players and commentators have identified the

10 percent return.”

increasing importance of relationships when investing in debt markets. The tighter grip regulation now has

From the issuer’s perspective, Carmalt has not

on liquidity in debt markets has led to deals being less

witnessed a marked increase in private placement

transactional and more dependent on relationships

activity: “A number of issuers look at both public markets

between the buyers and sellers of debt instruments.

and private placements because they use the latter to diversify their investor base. There is less of that sort of

Echoing this, investors say efficient communication is

activity happening this year because the public markets

critical when evaluating deals; 80 percent cited this to be

have been so buoyant and many issuers who would have

important or very important.They also prize the ability to

used private placements as a diversification tool haven’t

view documents quickly and efficiently with 79 percent

really felt the need to do that.”

saying this is important or very important (Chart 11).

Chart 11. How important are the following when evaluating DCM deals with a bank or issuer?

Ab vie ilit y w to fil re es ce o iv an f an e a d f y s nd or ize m at

Si m ea plic se it y -o a f- nd us e

f o Va in r m a lue d u ti - a s t on dd ry , d e in ea d sig l / ht

s t Ac - d ce e s re a l c sin po lo g r t se in g po

il an it y t de oc xp en e d tr a d i i te l i z e lig du en e ce

cu A bi m lit y en t ts o v qu ie i w effi ckl de ci y a n a l en d tl y do

se Sec ns ur i ti i t y v e /p in r ot fo e c r m ti at ng io n

c e om A th ffic m bili e b ie un t y a n n t l i c a to k / y w te is it su h er

90% 80% 70% 60% 50% 40% 30% 20% 10% 0%

Important or very important

Not important or not at all important

Carmalt agrees that communication is key: “Proactivity

transparency and provided market participants with

is the most important thing. The need to stay in front

better information.”

of clients has not gone away and that has been very challenging when it comes to COVID. As physical interaction is now very difficult, being on the phone or connecting over web-based platforms is even more

Investors in the study are calling out for better reporting tools for compliance and reporting in the DCM space. A large majority (64 percent) say this is necessary (Chart 12).

important than before. “You cannot build and sustain strong client relationships over email. This is a business which requires a significant

Chart 12. We need better reporting tools for compliance and reporting in the DCM space

element of personal relationship. It is this which

70%

engenders faith in your client base.”

60% 50%

As investors and issuers were pushed to work remotely,

40%

technology solutions that enabled client relationships to

30%

continue seamlessly became invaluable. In terms of the role technology plays in debt investing, Fitzgibbon highlights: “I don’t think we’ve made

20% 10% 0% Agree

Strongly agree

Agree + strongly agree

Strongly disagree

Disagree

particularly great strides in the way we analyze capital markets or the opportunities in various asset classes. That still lies ahead of us and we will probably need quantum computing to come into play before people take a different view of asset markets, asset allocation and

From an investor’s perspective, Groot says the fund he works for does not feel this need, although he understands why some investors may feel this way: “At the moment we have enough tools from an asset management perspective to reach our goals.

investing more generally.” “Although we are a relatively small organization, we are Glenn adds: “The role of technology within the debt

very technology-driven on the pension side and the asset

capital markets has grown significantly over the

management side. We want to be in control and want to

last decade. Access to real-time data has improved

know the details of all our investments if needed. We don’t

look at our portfolio on an asset by asset level every day,

extremely positive. Carmalt comments: “We’ve seen record

but if we need the information, we need to have the tools

volumes of issuance go through the bond market globally

which allow for it to be available.

at a time when investors, legal teams, DCM teams, issuers and all the operations professionals are working remotely.

Groot explains that the fund depends on custodians

This has been fantastic. Had it not worked for the banks,

and asset managers to provide reports and tools, which

investors and broader constituents, it would have made the

is why selecting the right partners is critical. “We have

environment very challenging.”

made some decisions to choose third parties that fit our requirements in terms of providing these tools. We

Currently, the primary way investors find out about deals

do this more now than we may have done in the past.

is through their research (26 percent), with virtual data

So, although we don’t directly make deals ourselves,

rooms (VDRs) coming in second (21 percent). For some

technology plays a big role in the way we invest to oversee

investors, roadshows, either physical (13 percent) or online

and monitor our assets,” he notes.

(9 percent), prove effective in learning about DCM deals (Chart 13).

The fact that global debt markets continued to work during a global pandemic, with some sectors thriving, is

Chart 13. How often are the following channels used to market DCM deals to you? 60% 50% 40% 30% 20% 10% 0% Virtual Data Room (VDR)

Physical roadshow or face-to-face meeting

Always

Online roadshow

Prospectus mailing

Often

Direct contact from a banker

Sometimes

Own research

Rarely

Bloomberg

Other

Never

Monitoring and control The 2008 financial crisis led to more regulation across

regulations, asset owners are less familiar with the idea

financial markets globally. The debt space was no

of regulation. Banks have been regulated for many years,

exception, as policymakers sought to stabilize financial

but asset owners are not typically regulated, or

conditions and seek to mitigate systemic risk. Examples

many have been.

include the SEC Rule 17g-5 on conflict of interest in the U.S. and MiFID II in Europe. The crisis also factored into the decision to end the use of LIBOR in 2021, though investors in this survey were not too concerned about that event.

“Further, although the asset management industry has certainly been regulated around how it deals with customers, it has been less constrained in how it deals with the market, with buying and selling of debt and what

Although over a quarter (28 percent) of investors say

it holds. The number of regulations that now apply to asset

regulatory restrictions have a high impact on their

owners and asset managers is growing and both types of

DCM investing strategy, this signifies the majority are

players are becoming much more regulated.”

considerably less concerned (Chart 14).

Although the majority of investors do not feel restricted by

Chart 14. What impact do regulatory restrictions have on your DCM investing strategy?

regulations when investing in debt, over half (58 percent) agree their organization is highly cognizant of new or emerging regulations, which could affect their DCM

50%

investment strategy.

40% 43%

30% 20% 10%

In the Netherlands, pension funds are grappling with a

28% 14%

14%

No impact

Not sure

0% High impact

Low impact

change in the way they have to discount liabilities. The system is changing from one based on interest rates to one based on expected future returns. Groot discusses the way the BPFD is handling this and the

Nugée points out, “Regulation is clearly an imposition. But

influence of regulation in general: “We have a very good

while there is a feeling that intermediaries have to obey

relationship with our regulator.The changes in the way

we need to discount our liabilities has had a major impact on our interest rate hedging strategy however we are

Opportunity in crisis

well equipped to meet those requirements. It will have an

Throughout 2020, broader market conditions have

impact on how we invest and how we hedge risk, but we

been largely supportive of debt investing opportunities.

don’t feel the regulator is asking for too much.”

Following a dip as the COVID-19 crisis broke out, the

He explains that this is also a reflection of the broader regulatory environment for pension funds in the Netherlands where the asset owners are not allowed to take on too much additional risk. As a lead manager of bond issues, Carmalt has witnessed a steady increase in regulation since early 2000, which rose significantly from 2009: “The increase in regulation naturally adds time and focus to the business, utilizing much more resource than it used to, but clearly for good reason. Most banks have been able to adapt quickly and

year went on to produce record levels in high-yield and investment-grade debt issuance as firms sought to raise capital. Investors are concerned about several macro events on the horizon (refer to Chart 7). This is filtering through to their asset allocation in that over two-fifths (44 percent) have increased their cash holdings in reaction to the pandemic (Chart 15). However, most allocations to broad asset classes remain unchanged as investors continue to expect uncertainty going forward.

manage these additional requirements well. Chart 15. How have your cash allocation expectations been affected by the events/outcome of the COVID-19 pandemic?

“While we may not see a material increase in regulation, I find it difficult to imagine any sort of relaxation of the rules. The focus on conduct and compliance and control functions is incredibly intense and I don’t think that is going away any time soon. The regulatory environment is also very dynamic, shifting and adapting as new

80% 60% 40% 20%

44%

18%

38%

challenges raise their heads, and so the regulators and bond market participants are likely to always be adapting with them.”

Affected increased allocation

Affected decreased allocation

Not affected same expected allocation

Industry players envisage 2021 to be one of turmoil,

percent for 2020, 1.6 percent for 2021 and 1.7 percent

which could also offer considerable investment

for 2022.

opportunities across debt markets. Fitzgibbon warns: “There will be attractive opportunity for institutional investors who are prepared to accept the fact that they are going to lose some money to defaults. As a result of that default cycle, they will be able to buy a lot of debt: be that straight corporate bonds, active, tradable bank loans or private loans. I think they will see opportunities in all those debt instruments.” From a family office perspective, Kennedy is bracing himself: “In the coming year, I don’t think governments will have as much liquidity to pour into the economy, making things a lot more difficult.”

According to Nugée, the high levels of government borrowing will put pressure on central banks to keep interest rates down even as inflation rises. In fact, in August 2020, the Chair of the U.S. Fed Jerome Powell announced it would be shifting its inflation policy to “average inflation targeting.” This will therefore allow inflation to run higher to support the labor market and broader economy. But low interest rates and rising inflation is not an auspicious outlook for fixed-income investors. Nugée comments, “It means financial repression. Real rates will go further into negative territory and you get the damaging

Another factor that may impact debt capital markets in

combination of artificially depressed interest rates while

the year ahead is inflation. According to the European

inflation is removing the real value of your holdings.”

Central Bank, the Harmonised Index of Consumer Prices (HICP) inflation is expected to increase from 0.3 percent in 2020, to 1 percent in 2021 and 1.3 percent in 2022. Though higher than present levels, these figures remain below the previous forecast of 1.7 percent expected for 2021 at the beginning of 2019. The U.S. Federal Reserve also expects a slow rise in inflation with median projections, as measured by changes in the price index for personal consumption expenditures (PCE), was 0.8

The concern around this is that investors may end up holding instruments, both in the corporate and government bond space, which they are unable to sell. Fitzgibbon calls this “hidden illiquidity.” He says, “When they need to sell, investors may discover the liquid assets they’re holding are a lot less liquid than they thought. If you find you can’t sell your publicly traded debt, this hidden illiquidity will become unhidden which will be a big problem for people not aware of it.”

Considering the action investors should be considering

Despite the tumult ahead, and the expected liquidity

in the face of this shift, Nugée notes: “Many pension

issues, Kennedy concludes, “There is always opportunity in

funds have either extended up the risk spectrum or got

challenging times. Out of chaos, smart people always make

out of fixed income altogether. However, as a group,

money. Within debt capital markets I expect more M&A,

they can’t do too much of that as many have mandates

loan opportunities and convertibles. We’ll also be boosting

which require them to hold a certain percentage of their

the conversion of debt into equity.”

portfolio in fixed income. There may come a point in the future when fixed-income investors finally decide that the negative real rate of return is just too high and they want to sell. This may be a time when governments will stop them from doing so and will use regulations to force pension funds to hold a minimum amount in government debt.”

In Laughren’s view, “I think by year-end the public fixed income market will better reflect the real depth of the economic downturn. In the next six to 12 months there could be a greater reckoning that the world has changed and the fixed income market could be forced to readjust to a dramatic extent. I don’t expect a complete economic collapse, just a realization that risk assumptions should

Although this does not paint a very optimistic picture

change, which means that opportunities are not going to

for some parts of the fixed income arena, investors

be found in the same places they were previously.”

should not be deterred. Fitzgibbon recommends a buy-and-maintain corporate debt strategy in face of the impending upheaval: “This is appropriate for investors who have a 15-year horizon and are going to hold assets for that long. Such portfolios would have a low turnover of only 10-15 percent per year. As opposed to an active bond portfolio which usually has 90 to 100 percent turnover.” Investors may not be worried about bounces in liquidity

“There is always opportunity in challenging times. Out of chaos, smart people always make money.”

as long as they have other ways of raising cash, should they need it.

‑ Jason Kennedy, CEO, Kennedy Group

Conclusion Although uncertainty is expected to persist, upheaval

Relationships will continue to form the bedrock of

in debt capital markets also presents opportunities for

debt investing, especially in the light of the growing

institutional investors. Regardless of market conditions,

allocations to private debt and more complex vehicles.

investors in the space will persevere. They have shown

As the prolonged period of remote working continues for

faith in these instruments and a strong belief in the vital

the foreseeable future, investors, managers and issuers

role they play in institutional portfolios.

need, now more than ever, secure ways of consolidating

Irrespective of any potential default cycle or liquidity crisis ahead, investors will need tools at their disposal to invest in fixed income. They have signposted the need

those relationships. Because of this, clear and efficient communication between all stakeholders will be critical to success.

for greater support in reporting and compliance, and also highlighted the growing role technology plays in the way they invest.

About SS&C Intralinks

About Institutional Asset Manager

SS&C Intralinks is the pioneer of the virtual data room, enabling and securing the flow of information by facilitating M&A, capital raising and investor reporting. SS&C Intralinks has executed over USD 34.7 trillion worth of financial transactions on its platform.

Institutional Asset Manager is the leading news source for the asset management industry, bringing in-depth industry knowledge together with access to the world’s largest institutional investors. Founded in 2010, its news, features and reports are read by fund managers and investment officers at the top pension funds, investment banks and endowments.

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