Pension Funds Reviewing HY Exposure

Retail investors aren’t the only ones reconsidering their allocations to high yield corporate bonds. Pension funds have become major players in this market, and some are thinking about trimming their exposure in light of recent gains, which have left them overweight. They are also concerned about the ability of noninvestment-grade issuers to make good on their debts as economic growth slows.

Leveraged Finance News recently spoke with two pension fund managers, Monte Tarbox, chief investment officer with the International Association of Machinists National Pension Fund, and Andrew Russell, head of fixed-income investments with the pension board of the United Church of Christ Inc.  Both remain committed to the high yield bond market, but are reassessing their exposure. Tarbox, who oversees more than $8.3 billion, is already overweight in high yield and is concerned that the market’s long run may be nearing an end. Russell, who runs a $3 billion fund, says investors are not getting paid as much as much for the relative risk of high yield bonds, but he’s even more concerned about the sensitivity of investment-grade bonds to movements in interest rates.

The interview, which was conducted through an online forum sponsored by research firm Clear Path Analysis, took place in August, before some of the junk bond market’s most recent excesses. These include an increase in such features as PIK-toggles, which allow for payment of interest in the form of bonds, instead of cash.

The interview also preceded the flight of capital from high yield bond mutual funds, which have been pulling in new money hand-over-fist for much of the year, but have seen more than $1.2 billion walk out the door since Sept. 19.

(You can access the full interview, which was published in September, at

LFN: What drew you to invest in high yield bonds?

Tarbox: Our interest in high yield bonds comes from a strategic asset allocation exercise we do every five years. We last went through this exercise in 2008, and we are working with our consultant now to redo that based on recent experience. But we concluded some years back that high yields are a good diversifier particularly to our fixed income asset allocation, but they also help total portfolio returns by diversifying some of the risk. This is not at all a tactical play on our part or something that we have done recently as we have been in high yield bonds for quite some time and compared to our peers we are relatively overweight. We’ve got a little bit under 5% of our total plain assets in high yields so it represents roughly 20% of our total fixed income allocation of almost $2 billion.

Russell: Historically the focus of our bond fund has been investment grade bonds.  For many years investment in high grade bonds had more than met our internal return requirements. During the U.S. financial crisis, the 10-year Treasury rate had fallen to an unappealing 2%. We were looking for new opportunities and a way to increase return. Once the fallout from the financial crisis began to stabilize, we began to consider investing in high yield bonds.  Default rates had skyrocketed and recovery rates had tumbled but valuations had tumbled too. As balance sheet cleansing began to take shape, defaults dropped and recoveries improved and we grew more comfortable with the idea of high yield bonds. Whereas our interest back then was driven by the possibility of earning more capital appreciation than we would have in investment grade bonds, our interest today is driven by the opportunity to earn greater interest income and also protect the portfolio to some degree from the price crippling effect of rising interest rates – although higher rates any time soon is not our base case prediction.

Was it difficult to expand your mandate to include high yield bonds?

Russell: Our mandate already included high yield bonds at the time but we had historically not been very aggressive there. Our guidelines have always permitted us to invest up to 10% of the bond fund and let me say that we have a couple of different pools of money here but our primary fund has been and is permitted to invest 10% in high yield.

Do you have any plans to change it given the current conditions in the market?

Russell: We are content for the time being with our 10% ceiling on high yield bonds.  Again, our interest in high yield bonds currently is relative.  It’s more about our lesser interest in core bonds than it is about great opportunities in high yield, where rates are also near historical lows.