Dynamic debt investing – with Charlotte Vincent, co-head of fixed income at People’s Pensions

[Music] Hello! Welcome to the Professional Investment Podcast. I'm Charlotte Moore, award-winning journalist and co-founder of Moore Square Communications. Each episode we welcome a guest to the show to share their new story of the week. And I'm delighted to welcome Charlotte Vincent, co-head of Fixed Income at People's Pension to the show. Welcome Charlotte. Thank you Charlotte. Thank you for having me. It's doppelganger central here today. Not only we both call Charlotte, we both got co in our business title. It's all a bit creepy. But do tell us what is your new story of the week. So my new story of the week was a Ron Moore inflation shock set to full short of the 2022 surge. Now it seems a bit it's kind of odd asking somebody at Fixed Income why there was a story about inflation of interest to you. But do tell us why is the story of about inflation of interest to you Charlotte? Well it boils down to the key reason I do my job and why they pay me hopefully is that all I'm basically here to do is produce good member outcomes. I want we want to provide a solid retirement income for those in the future. And to do that we have to get all our members real returns. So it's not just returns it has to take into account the inflation. So if you if we don't 10% and inflation was 10% wasn't wouldn't be a great result for our members there. So real returns basically is what's going to give our members their best outcomes. So that's why we really care about inflation. Yeah and Fixed Income is obviously only part of that portfolio but that's your domain and we there's obviously other bits of the portfolio invested in other assets which also hopefully produce real returns such as equities and private markets and all the rest of it. So it's all part of the mix isn't it? Yes, no it's a luckily it's not all down to just one side that hopefully you have all all engine firing but it's sometimes some are going up and some are going down and you're hoping that what the outcome of that is you've produced a good overall real return across the whole cross the whole portfolio. And I think it's fair to say that people's pension has a different approach to investing in fixing them to other master trusts and that really came about when you assigned investment as your fixed income manager back in February last year I think it was. And you've got you've got a lot of dynamic elements that fall at portfolio so talk to us about how you approach fixed income at people's pension. So what we want to do is again going back to those member outcomes we need to make these real returns but obviously the world changes the world isn't static so what we have to do is a toolkit that we can basically be dynamic and flex different ways according to what the what we require at the time so what we built into that portfolio was some key attributes which meant that we have some regional aspects we can decide to be focusing on Europe or US or focus on the UK or focusing on emerging market debt that we also have a quality scenario that we can be at the top with the triple A's or we could be all the way down to the single B's if we're looking at more high yieldy aspects. We also given ourselves the lever of when we want to have where we want to be active or passive so actually we tend to be more passive on the higher rated very liquid markets like government bonds whereas we're absolutely active as you go down that quality spectrum or as if you go into more complex instruments. We also yeah we have a duration by us to week we want to go at the short end of the curve the mid end of the curve the long end of the curve where do we where do we feel the best value can be found. And what that really just does is it enables us to to create those member outcomes for different members at different stages in their journey so if you're a growth member you're looking for you've got a very long time horizon. You're going to be looking for you know you're less worried about drawdowns because you can recover from this and you're looking for some great assets whereas if you're about to retire in three years that the last thing you want is to have a big drawdown which would do that so you have to you have to use different tools and you know basically think right how do we sell that right answer for the right member and taking into account what they require. Okay and that wasn't enough that you had this dynamic fixed income portfolio then about sort of six months later in October last year you also invested 250 million collateralized loan obligations also with investor talk to us about your thinking behind that. So for those who know CLO's they we invested it that was our first investment CLO with the first DC master trust to do so and what we would do is investing at that top level that triple A level and CLO's sort of one of the most fantastic instruments especially for pensions because what they have is they have especially that triple A top it got over 20 years zero default. So you know this is this has been tested through co-made through the GFC like this is a this is a very very strong highly rated so it's giving me high quality assets. What it's also giving me is quite a lot of diversification because when you go into when like asked your investing in CLO's I'm not just investing in what with you know whilst invest go running the fund I'm investing across 40 50 different managers so I've got some manager diversity. I've also got vintage diversity so I'm not just investing on the deals that were made last week last month I'm investing in some deals which were made five years ago so I've got a nice range of diversity there. Finally the best thing is got the industry diversification so the thing that scares a lot of people is when you have those manate you know those industry concentrations whereas actually in the CLO market you have to have a diversity so you have to be diverse you're like they test this on a monthly basis so you can't ever get these massive concentrations built up of wood. If you percent in healthcare because that's we fancy to do no no no it's very very very diverse and beautiful pie charts for these different industries because there's lots of different. But the other aspect of CLO's is that they have this huge structural protection so when they were created originally sort of the late sort of 90s early 2000s they sort of they made them very secure then and our post GFC even made a survived GFC. And they they survived GFC and did very well they the people went back and actually we can do more here's actually we've got so much coordination below us we've got about. And it would be 35 and 40% of an equity question which does give you obviously which is why you've got that zero to four rate because it would have to eat through a lot to get there and they really tested that and I think I think there was a great study that they tried to put they tried to see with it sort of the default rates went up to 20% for five years in a row and it still wouldn't hit the trip base. And obviously if we've got 20% five years in a row we've also got a lot more problems than that but yes and finally it's that complexity premium that because they aren't so well understood that actually compared to all the other instruments of triple A instruments they quite they pay quite a bit more so they're just widening a really good risk of just to return to us and the fight again so I keep on saying like so many things but they're floating rate. And what that really adds to us is it takes away this interest rate sensitivity that fixed income has and it means that you know obviously it's still you know there's always risks there's no things no such things are free lunch so to speak so but we're shifting that to the credit and and yes that floating rate means we're taking out we're adding in a part of the portfolio which isn't going to be so affected by interest rate movements as the rest of the more fixed income part. Yeah and. That floating rate I mean given that the original answer we talked about is basically Godman saying that they don't think the inflation shock because of everything that's going on the streets of hormones is going to be as profound as initially thought. And then we've been through like over the last 12 months we've been through so many different. So you know ideas the market has had about where interest rates are going to go and it's just been. It's been a bit mad but actually at the same time but especially for the serial o-tra place it was actually a really good proof of concept is when you've had these market because they're not the market volatility you know since the start is at the end of February it's been mainly in rates it's not sort of like credit spreads haven't widened directly but the rates effects obviously have caused issues. And so whilst you might have seen the guilt trading down even the IGE trading down it's not trading now because I think they're going to default it's trading down because of the rates risk attached to it with the duration. Whereas serial o-tra place just keep on trading people going at one stage I that's not the case now because obviously we've seen some recovery but for most of March it was our best performer in the whole portfolio. And that's not where we obviously we didn't it's we didn't like to be the highest yielding but it's just because of that rate volatility and that protection from that actually meant that those serial o-tra place was did exactly what they were supposed to do. Okay, so we mentioned that you've got all this dynamic. elements in your portfolio and that you can shift everything around duration and regions and sovereign and etc etc. You know every every which way that you could cut fixed income you seem to be able to move along a line about where you want to be. So I think you've just gone through your annual fixed income review. Give us a bit more meat on the bones and you've got all these options. What have you actually chosen to do with it and how have you chosen to change it? The first thing is back to that member outcome is that we have two. We have one very large default fund which is for our growth outcome and then we have our pre-retirement. So last year we separated those and that actually has enabled us to again use that toolkit formal effectively to answer the correct questions for the correct groups there because as we said that long time horizon for the for the growth fund what we were doing there is because previously there were a bit commingle we were able to sort of look at that and think actually we do want this to be more grozy we can actually increase the risks slightly here we can actually so we increased our allocations to emerging market debt and to higher yield there. We still retained our key anchor core portfolio is in the IG because that is that sort of solid, secure bit there but we actually were able to move the dial up there whereas actually in our pre-retirement portfolio that has that short time horizon where we can't have those dips we can't even even in times of volatility we do want that to ever sort of be sort of hitting the returns massively. So what we were doing there is actually using those triple A's again so we've diversified the risk there so previously with a fixed income we've obviously did anything with duration has a rates risk by adding in some more floating rates we were basically diversifying our sources of risk there but whereas what we haven't done is we have a small allocation to high yield but otherwise it's that IG that IG and the triple A so it's incredibly highly rated for that retirement portfolio to ensure that we aren't getting those dips we aren't going to get those drawdowns that we're just really looking at to sort of income preservation I suppose would be the correct way there. So apart from sort of splitting out I mean if you were to take that to your logical conclusion you might decide to go for a target date fund approach instead actually no because then you could like as people move through that journey they would know exactly how far away they were I mean I know that this is the only person with target date funds but I think I think we actually we think that the that actually our pit so if we're looking at the our retirement product pre-retirement product so to speak that's actually on a glide path so so when it becomes really important when it when you do in effect have you know you're thinking am I 10 years away from retirement my eight years away from retirement whilst we have a pre-retirement fund on the fixed income side the glide path is how much you're going into that versus the normal fund so in effect you're kind of using that glide path you're kind of getting this target date returns was the same time still solving the big issues rather than trying to just micromanage and sort of little little adjustments whereas we think yes our default fund if we look at our default members I'm going to get the I think our average member is about 33 I might be wrong is if between let's say between 28 and 35 it'd be that well cover a nice thing but so yeah we believe that these people actually you're looking for the same thing you're looking for that long time horizon you can take on more risk you're looking to get these returns that really mean that you're going to be able to build your pot up ready for when you get to later on in your life so apart from sort of splitting the fund between the pre-retirement and the retirement and you've talked about how you take you want to invest in different bits of the fixed income universe in each of those which makes sense have you changed anything else on that dynamic glide you know you've got all that dynamic ability have you change your views on duration for example or change your views on waiting between sovereign corporate anything else apart from sort of a set so we actually have so our pre-retirement doesn't have any exposure to sovereign debt and in our growth fund we have been reducing our exposure to sovereign debt on the that's partly because I think there's lots of questions what to sovereign debt provide and the main thing that you know sovereign debt is fantastic for is liquidity and the one thing that we aren't in massive need for is liquidity so our our need to have those sort of you know the treasury market is open all day every day like you can always access it it's a fantastic market but the fact the matter is when you are 25 you are do you're not accessing your pension for at least another 30 years we don't need that liquidity in that grace phase so what we sort of have to look at is then we then go to that IG portion which I said we can have those regional biases and we can have those duration biases we actually have been more biased towards a short duration for quite a while for the last couple of years at least that's been done on purpose because we didn't really feel that we were being compensated enough to take out that duration especially as you know the Kurds at one state or two were both flat which means that you weren't getting paid a massive amount of premium to extend if you extended your maturity and yet by extending your maturity you did increase your risk quite dramatically because the longer duration gives you that bigger swing with any rates movements which obviously we've been seeing and also because we do believe that we had beliefs and sort of whether the Kurd was going to steepen more at the long end as well as just coming down at the short end so we actually we really like the short duration for the investment grade portions. Originally we are a UK pension fund we do have a bias to actually the UK on that one but it's not a huge bias I find being honest it's pretty evenly distributed but there's a slight bias towards a UK and then the emerging market death and high-owned markets actually automatically quite a bit lower duration so they they don't add much in duration they're again the focus there is on that really active structure that really bottom up every you know we only put but when I say we are managers you know we only put only buy something that they really know really understand and really believe as additive so if you're in a passive index let's say the passive high yield index might have 2000 names we're probably only going to be investing in about 300 of those names so but we're investing in the 300 names that we believe are the best 300 names so we're just not going to invest across the board with very active and very selective. You mentioned there that you don't have a lot of sovereign in any part of your portfolio because you don't need the liquidity and I think that's a really interesting chance of sort of an interesting light on something that we've touched upon in this podcast before which is with a sovereign debt as you know DB dies or not managed to die is probably an exaggeration because it's probably going to be with us for a nice amount. Gently extinguishes probably more accurate and it's probably going to be with us next 30 or 40 years but if people's is indicative of what other DC schemes do over time and you just don't see the need to have sovereign debt and especially not guilt markets which is you know the UK guilt market has been so heavy reliant on pension schemes sort of mop up all of their issuance. That's going to be really interesting as it pan you know it's going to be a long game to watch it unfold. It is and fun enough and it was something that we could put there was another article that was in the FT over the weekend which is always taken it was from Alphabet I love Alphabet and actually you know it's they're very funny they're very witty but they did not call saying what if we ran the debt management office? How what would we do differently? And I think what what they did is they really honed in on your point there which is that those long dated guilt have were brought up by those DB pension schemes for a long long time and in fact the DB pension schemes kind of got an adoom if they had to buy them because you know as they bought them but in the yield went down which meant their liabilities went so they had to buy more and more and more as that's gone away yeah the buyers for that long end aren't there really anymore. In fact the people who are buying in the long end at the moment are more hedge funds they're the ones who are taking you know and hedge funds are definitely in there they're not in there for the long term they're taking positions because they believe they can benefit from that and this article it was really interesting because they they pointed out something which I have to be honest I hadn't noticed because it's not something we've traded but they were basically pointing out that we don't really have that really short term T-Build market and that actually that that's where because that's a cheaper end of the debt and that's you know wicked that actually we should they should be doing far more there and I I thought it was an amazing piece because as I said T-Builds aren't going to be something we invest in personally because they're too short term. But actually the fact that everyone else is doing the tea bills and we are not does point to something that maybe Alfaville, even though it was reasonably very well researched, but it's like you're tongue in cheek. Actually probably have hit one quite a good solution to the fact that you don't have any buyers at the long end. You've got lots of buyers you want to buy at the short end. We don't issue any short end out. And we don't do that. It seems like a bit of a mismatch now, but again, it is a fun article, but it's written by Toby Nangle, obviously everybody in the street at all is Toby Nangle. But it's a hilarious piece because I recognize it as a fellow's pension ski because it was basically, it's a bit of a Trojan horse article. It was basically, I'm going to unload everything you need to know about why the pension market is the way today and it starts where I would start, which is, let me tell you about this geezer called Robert Maxwell. And he's basically running off with the Daily Mirror Pension Fund. Before we fell off the vote and became the only Bob that didn't. It's a very long article, which is basically, Toby's, I'm going to download my entire brain as to why we have the market we have today in one piece. It's good fun. It's very illuminating and educational. And actually, this one didn't have it so much because I think it was such a long article and so in depth, but usually without a bill actually it's the comments that you know, they often say don't read the comments because you actually decided to get silent about humanity. But actually, the alpha bill comments are always really, really good value and often really insightful and they sort of bring out so if you win shorter articles, they often sort of come in with things like, oh, yeah, that is quite good. Not you know, they make a correction saying I think you need it. I didn't realize this like the way there's something you have to consider for people's next year for your entertainment budget that alpha bill has the geekiest FT has the geekiest sort of financial quiz ever in existence. And that happened today. I'm like, you know, I think you have to be, I mean, I think it's often they have really good expert. They literally have they have every week as well, like two charts. And they literally just show you a chart with no nothing there and you just have to recognize and the answer's like, oh, that's that's less late free cash flow or something. So what will you see there would be people out there who every week get and they have, you know, they don't give you anything it's like literally it could be a share price. It could be anything. What it isn't is the things that you know you and I would go, oh, is that the starting. I know, I did look at the quiz ago. I think I would get one out of 100 and I'm a financial geek and then but it also the question is very hilarious because it is basically it would reward a financial journalist who like lives. Freeze news every day all day. Basically you could see that that's exactly what's the sign for. But you know, I think Charlie should you've got a year to prepare and spread every new story and you need to build build a people's team for the app to. I think I will. If you go to the unhedged podcast, they do one where they just I think they just drink. They just go to pubs and that they want to tend to be a bit less tough on the brain a bit more bit easier, a bit harder on the wallet maybe but. But yes, they they seem a bit more on the fun side without actually having to learn 8 million charts. I might go into unhedged instead of the alphabet. But then again, you know, you and I should do a team together because we could just call it the charlots right. Exactly. I've got more squared because I've got a yes, exactly. Of course, of course. Well, yeah, I mean, I've had a pun. Obviously did that on purpose. Anyway, back to the sexy world of fixed income. We have to get a great tangent there. So over time, how do you see that whole your whole fixed income portfolio developing further other other areas that you want to invest in aside from CLOs or. Is it back more granularity or is it about maybe giving up the fund is it about. I mean, I know retirementing and then something you're still thinking about you haven't designed it, but that's obviously going to have a fixed income element to as well. Yes, I think there's definitely fine. I think there's obviously some post retirement work, which is going on. I know that the government still sort of coming out with things about that. We're work there working people working very hard on that. Although I do think probably even when we do that from the fixed income side, most of our toolkit could probably utilize there might be one or two small gaps that they might want something a bit more niche. Certainly a bit more like the DB's that sort of not LDI but sort of like those sorts of aspects. But the biggest actually thing that I think we need to focus on is more on that growth area. Is it since that separation of the period of time and the growth that does really mean that we need to look at the fixed income growth and really work out. Have we got enough growth in there? Are we doing enough? And the big caveat just has to be that member outcome, which is so important. We're not here to place bets. So we can only ever do something when we have fully researched it. And that is an it's not a date, you know, process of moments. So myself and my team are certainly going to be really looking into aspects of private credit. We're certainly looking at more growth the areas of Mac funds areas that basically so we talked about the CLO triple A's. Obviously you can move down that spectrum. You can go into the mes portions. You could look at the CLO equity. But the fact the matter is. As I said, these are not a work of moments. And sometimes you can do a lot of work in and the answer still might be actually don't think it adds enough or is it, you know, it's it's going to. You're going to have some very key criteria, everything's going to hit. But obviously part of our role is that I'm going to constantly have to look to make sure am I looking at everything. Is there anything I'm missing? Is there is a you know. Is there something that would really add a secret source so to speak. But yeah, now it's just a lot of hard work and making sure that we have all the information to hand. We mentioned private credit there. I mean the other the kind of the flip side of your argument about we're not really interested in soft and debt because we don't need liquidity. UK government is going to have to start issuing something that people actually want to buy. Flip side of that is everybody hearts global credit basically. You've got on the on in another sort of aspect of UK pensions you've got. About 550 billion forecast to flow out of DB pension schemes and into insurers by buy out over the next decade. And insurers love global credit and you guys love global credit to and you've got all of your receipts coming through you've got all of your you know your contributions coming through every month. So I wonder if as kind of like nobody wants to invest in sovereign is everybody who's left in the pension market going to be chasing global credit and. We've discussed this before on the podcast with targid saying about how there isn't really the UK for bond market hasn't really grown for 12 10 years and it really needs to grow and is that something you're thinking about is there enough. I do it was Mario Drahis paper which I think is is actually going to be really pivotal pivotal is that Europe. Europe doesn't have a huge secure organization market and they've done the studies and they think we're losing about 1% of GDP. I mean that's huge. We could add one century to be just by expanding our securitization market and that would also give flows into those required investments there. The problem is you know it's it's a I think they're starting to work on it I understand that is a lot of work that has been going on and we're hoping to hear every more that papers now over two and a half years old. And I think that that is going to be absolutely essential that Europe needs to actually come together and work out I've had my own crazy ideas but I will only share them over a glass of wine because I'm not sure if they actually stand up to actually to reality. I think we definitely want to have that secure to building out that securitization market in Europe having some consistency there I mean. At the same time yeah does it have to be securitized though or could it just be an expansion of the loan market. If it's kind of the same thing if it's still corporate debt does it matter if it's public or it's private. So that's the securitization aspect so that you've got the more the ABS you've got all those other instruments that you know that the fact that you know in I mean. Fanny Freddie and Ginny have been around for a very long time and yet we have no mortgage securitization and I think we've all been looking at the states in the last few years thinking gosh why didn't we have 20 or more. And the answer is of course they haven't been able to securitize the wave would that person me I think that would be a very great thing to have. But yeah so not everything so corporate wise I think you're right that could grow but those this is other areas of securitization so that looking at that ABS looking at credit card receivables looking at all those other aspects that just if you that people want to invest and you know and and actually there's a limitation at the moment. If you build that out it's a it's a kind of a build it and they will come scenario that if we build out that securitization market it would enable. able more growth projects to be done. And I think there was another FTR article but some months ago, and it was reasonably depressing. It was sort of saying that I think they tried to get, they tried to do some building of it. What wasn't an AI thing, but it was a similar like building out a project. And in Europe and they'd managed three so far in the year. And at the same time in the States, they've done 300 sort of thing. So it really does actually hinder our growth. So by growing out in the curitization market, you're going to free up, loosen those conditions, find out who gets more borrowing, gets some more lending going on. You can't have one without the other obviously. So that could only be a good thing. I think the, certainly the other aspect which is quite interesting there that does borrow me is that basically that, well, I love those triple ACLOs, is as more people go into that beautiful, complexity premium that I really enjoy, might start to diminish slightly. So that's the fact that, so whilst you want more people to get into curitization, so downside is the more people understand them, the less people like me who can benefit from the fact that people don't understand them as well, and I can actually be paid more for doing so. - I mean, in life, it is rare to be able to spot a trend. It is even rare to be able to spot a trend that you know is going to last multiple decades, right? You know what, what retailer wouldn't give their entire body in order to know what people are going to buy for the next 20 years? And given that we've got these two massive trends, we've got insurers absorbing DB money, and you've got DC growing and growing, growing, also wanting corporate debt as well. I mean, you've got the demand, you just have to create the supply, right? - Of course, it's crazy. I was doing, to never give life to never give you such an easy demand prediction like that. You know, that is a trend that you can get on for the next 20, 30 years. - Which is what makes it so frustrating that it hasn't happened yet. It's sort of like, and if you speak to everyone, everyone in the room agrees with you. No one's like, yeah, no, it's a fantastic idea, and you're like, should we doing it? And they were like, oh, no, sorry, we haven't, you know, we haven't quite worked out how that's going to work with you, you know, it would be Jeremy or Farms or et cetera. So you're like, choice, everyone in the room. Like, maybe we should just do that, and not the more in the room. Can't get out until you just agree. Come on, guys. - Sounds good. I think now that we've solved all of the world's problems, and we've got our pub question. - No, no, no, no, no, no, no. - I think that's a great point for us to end the podcast. Thank you, Charlotte. So much for sharing your new story of the week, and all those fascinating insights into how you think about Fixed Think I'm and how you manage it for people, pensions, members. Listeners, if you want to make sure that you never miss a future episode of the Professional Investment Podcast, make sure you hit that subscribe button, and thank you so much for listening. (upbeat music)