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Paper shows other approach to high-yield credit
03 July 2014
JPMorgan’s Paul Sweeting says mark-to-market is not the only way for pension funds to invest in high-yield credit
Long-term investors should consider a different approach to
investing in high-yield credit than merely mark-to-market,
according to Paul Sweeting, MD and European head of JPMorgan
Asset Management's Strategy Group.
Sweeting spoke to Global Investor/ISF about his new
research paper on credit and long-term investment, The
High-yield bonds present several advantages for long-term
investors such as pension funds, yet many are naturally
concerned about volatility and credit risk.
Sweeting said that while many investors need to mark their
assets to market, there is an alternative approach to investing
in high-yield. While the level of income generated by
investment is closely related to the level of credit risk, his
research finds that credit risk is not the only reason for
"Rather than looking at how to time the market, this paper
looks at the case for investors considering whether credit
asset classes make sense given their level of confidence and
the time horizon they might need for de-risking their
"A long-term investor or pension fund shouldn't necessarily be
too concerned about volatility of different asset classes,
particularly in the credit spectrum. Just because spread moves
in and out doesn't mean income will be adversely affected. In
2008-2009 spreads moved out very sharply for low-rated debt and
income kept tumbling in.
"For example, if you're investing in high-yield over a 20-year
horizon then providing the spread is big enough at the
beginning, you'd expect to squirrel away enough in additional
coupons that it doesn't really matter what the spreads are in
20 years' time."
His analysis shows for what period of time investors need to
hold credit assets in order to give them a "reasonable degree
of confidence" that they would beat US Treasuries.
Sweeting said this can be particularly beneficial for pension
funds that need to take a long-term view.
"It's important to have a good idea of the underlying economic
situation of the pension scheme rather than just
mark-to-market. This approach is important for defined benefit
(DB) pension schemes as many of them have deficits so need to
invest more aggressively.
"Many might feel nervous about investing in high yield or
emerging market debt because of the additional volatility but
if you're investing in credit for a long-term horizon,
providing spreads aren't too narrow, you have a very high
probability of beating your liabilities or the US Treasury
benchmark over that time, including being able to make pension
In the paper Sweeting said that by the amount needed to beat US
Treasuries at shorter time periods is higher for high yield
than for investment grade if the spreads are ignored. However
as high-yield spreads are higher, the buffer built up leads to
a fall in the amount needed to beat Treasuries.
For example, if the high-yield spread is 3.82%, there is a 75%
chance that investment-grade corporate bonds would outperform
Treasuries over a 15-year time horizon. The probability of
outperformance rises to 90% and 95% over 18 years and 20 years