Creditflux Newsletter

On one side of the dance floor is an industry that manages $17 trillion dollars of long term money. It’s desperate to boost returns and reduce its exposure to equities. Propping up the bar opposite is an asset class that has historically outperformed most others on a risk and inflation-adjusted basis. So why aren’t pension funds and credit falling into each other’s arms?

Every credit fund manager in the world can see why pension funds should love what they offer. The pension funds’ big problem is finding investments that match their fixed future liabilities. That calls for investments with fixed pay-outs – in other words, bonds. But bonds issued by the US treasury are not going to yield enough to pay the bill. So, it would seem, every pension fund in America – indeed, every pension fund in the world – should be looking at credit.

But the pension industry is fragmented, especially in the US, which has a proliferation of small schemes. So credit fund managers need to spend a lot of time on the road in New Mexico and Wyoming to meet the decision-makers.

Yes, you can cover a lot of ground by attending “guns and hose” conferences, where the fire service and police pension trustees gather to be entertained by pension consultants and drink Budweiser. But then you run into another problem: because the schemes are small, the trustees are rarely finance specialists. And that leads in turn to the really big problem: the reliance on pension consultants.

“Bouncers” is one of the least offensive descriptions that asset managers use for pension consultants, who are commonly said to lack much understanding of credit. But the main problem is not the caliber of the individuals involved but the fact that the consultant firms are incentivised to err on the side of caution. If they take a risk by recommending a new manager or strategy and it goes wrong the consultants risk losing the client.

This tendency to play it safe means that when money is allocated to credit, it goes to the small handful of managers who are on the consultants’ approved lists. This is the reason that the biggest credit managers, such as BlackRock and Pimco, have succeeded in winning such a large quantity of new assets in the past couple of years.

Even so, some smaller credit managers have succeeded in attracting US pension money, especially from the handful of pension funds that do not rely on the consultants. California’s San Bernardino County Employees’ Retirement Association, for example, has invested with a number of managers, including MKP, Tricadia and Cairn Capital (none of which are well known names in the suburbs of southern California).  The timing of this fund’s investments, in late 2008 and early 2009, suggests they should have performed spectacularly well. But the scheme remains highly unusual in making these more adventurous moves.

The low visibility of credit in the US pension industry has prompted one trade body, the LSTA, to launch an awareness campaign to educate pension trustees and consultants about the benefits of loans.

Managers in other areas of credit should probably be doing the same. Instead of propping up the bar – or going out alone and knocking on hundreds of doors – they should be working together to show the pensions industry what they can offer.

After all, if just 10% of the 50% of the US pension money that is in fixed income switched into credit the inflow would be huge. Most credit managers would be very happy to manage just a tiny fraction of that flood.