Junk Bond Limit Near for Pension Fund That Doubled Exposure

  • MLC ‘might even peel back a bit’ on credit, Stuart Piper says
  • About three quarters of manager’s bond portfolio is in credit

Australia’s second-biggest pension fund manager is reaching the limits of its appetite for corporate credit.

MLC, a unit of National Australia Bank Ltd. that oversees about A$20 billion ($15 billion) in fixed-income assets for retirement savers, doesn’t want to increase credit risk further after doubling its holdings of junk-rated debt to about 10 percent over the past 12 to 18 months, said Stuart Piper, the manager’s Sydney-based head of fixed income. The portfolio’s corporate credit holdings have risen to about three-quarters of the fixed-income total from around half, he said.

Extraordinary monetary easing from Europe to Japan has weighed on yields, forcing investors worldwide to move away from the safest assets to generate income. That’s driven global junk bond returns of 15 percent in 2016, putting them on track for their strongest year since 2012, according to a Bloomberg Barclays index. And while speculative-grade yields are near a two-year low, S&P Global Ratings data shows corporate defaults are up 55 percent this year.

“We can load up on non-investment grade credit, but if the equity markets really tanked, instead of our bond portfolio rallying, our non-investment grade would probably tank with it, which doesn’t provide great diversification,” Piper said in an interview last week in Sydney.

MLC, which oversees over A$70 billion on behalf of more than a million superannuation fund members, is the largest manager of pension funds Down Under after AustralianSuper. 

While the firm is “not negative” on credit investments, valuations aren’t “fantastic” and some fundamental credit metrics have deteriorated, Piper said. “It’s not an improving environment for credit. If anything, we might even peel back a bit.”

The scope for generating income in government bonds is also hampered by record-low interest rates and diminishing prospects of additional central bank easing. Australia’s benchmark 10-year bond rate was at 2.25 percent as of 5 p.m. on Tuesday in Sydney, having fallen as low as 1.81 percent in August. The Reserve Bank of Australia’s cash rate is currently 1.5 percent and the odds of a rate cut by the end of next year are less than 40 percent, according to swaps pricing.

Piper reckons that while a strengthening currency could prompt an additional reduction by policy makers, RBA Governor Philip Lowe is more likely to remain on hold. Slashing rates further is “probably not going to be very useful” as further monetary easing will push investors further into riskier assets such as equities to chase income, Piper said. “We could be on hold for a couple of years, certainly the rest of next year.”

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