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Using short duration
credit in our client’s portfolio to boost liquidity and maintain expected returns

Case studies

How we helped a client meet cash-flow needs without sacrificing expected returns

The background

Earlier this year, we helped a client to review their UK corporate bond portfolio in light of a growing need to draw income from a portfolio of assets to meet spending requirements. In particular, in this new world of low-interest rates and low yields the client was also re-evaluating the role of traditional UK corporate bonds in the portfolio.

The solution

Our client was thinking that liquidity within the portfolio could be improved by either reducing the allocation to UK corporate bonds and boosting the allocation to cash, or perhaps by setting up a rolling program of selling down the UK corporate bond portfolio. The first option would only temporarily boost liquidity and so liquidity issues would return. The second option would seek to generate liquidity from a relatively illiquid asset.

Instead, we recommended that the client switch their allocation out of the traditional longer-dated UK corporate bonds into a portfolio of global short-dated credit. The short-dated credit manager we proposed has a portfolio of corporate loans with low maturities and the following characteristics:

Performance target

Cash +1.5% pa (after fees)

Average credit rating

BBB+

Number of issues/issuers in portfolio

c. 160 issues

c. 130 issuers

Duration

(1 to 5 years) with an average of 2 years

Total annual fee

0.12% pa

Financials 26% Cyclicals 16% Non-cyclicals 8% Industrials, utilities & energy 36% Telecoms 10% Other 4% Sector breakdown
UK 35% US 19% Europe 37% Other 9% Geographical breakdown

The LCP difference 

There were many benefits to our approach, including:

  • Benefit 1: Avoid many trading costs because a diverse portfolio of short-dated credit matures quickly on a rolling basis so liquidity of the portfolio as a whole is significantly improved with little need to actually sell assets;
  • Benefit 2: Reduced trading costs if you are forced to sell the assets for liquidity purposes because short-dated bonds are much more liquid than traditional corporate bonds;
  • Benefit 3: We expect better than cash returns over the long term because short-dated credit maintains an exposure to the credit risk premium;
  • Benefit 4: We expect a further boost in expected returns over the long term because short-dated credit spreads often exceed long-dated credit spreads due to the constant pressure of high demand from institutional investors for long-dated credit;
  • Benefit 5: We expect a further boost in expected returns if interest rates start to normalise and increase – this is because you can reinvest at the higher yield and capture that extra return, which is why this option offers so much more upside; and
  • Finally, the risk of losing money is reduced because the default risk is lower as as you are holding the loans for a shorter period of time.

 The outcome

The resulting portfolio met the client’s increased spending needs, but also improved the expected risk-adjusted returns of their investment portfolio. Given LCP’s independence and long-standing relationship with the short-dated credit fund managers, we were also able to negotiate a significant fee reduction from a standard fee of 0.25% pa to 0.12% pa for our client.

How we can help

We help central banks design and implement investment strategies to get the most out of their reserves in a risk-controlled manner. 

We help charities and endowments construct investment strategies and pick the right investment funds to both meet their financial objectives and be aligned with their missions.

We help our clients to maintain a competitive edge by improving their investment strategies, generating extra returns in a risk-controlled way.

The LCP Wealth Drawdown tool is designed to help advisers and other individuals explore the impact of charges and other factors on your pension in drawdown.

Our investment team works with trustees of DB and DC schemes to set bespoke investment strategies and select fund managers. Using our market-leading technology, we help you navigate your journey by providing you with clear, actionable insights which enable you to make better short and long-term investment decisions.  

Setting a good investment strategy and picking the right funds is fundamental for wealth managers and advisers to be able to deliver better outcomes for their clients. Our role is to advise clients on investment strategy and fund manager selection bringing institutional discipline to the retail market.

Every sovereign wealth fund has its own unique circumstances and challenges. As an independent consultancy, we’re not linked to any asset manager and we don’t sell investment products.

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