Thank you for tuning into our perspectives on credit. My name is Julie Ducharme. I'm a portfolio manager at PH&N Institutional, and I'm delighted to share our insights with you. Now, the reason we picked this as an educational topic is that there's been a lot of interest from institutional investors on credit, and we've seen an increased allocation to the space.

But what muddies the waters is that credit is not homogeneous and not all credit is created equal. There are many different types and there's many different ways to incorporate it so as to optimize your portfolio from a risk and return perspective. So we're going to cover all of that in this session with the hopes of giving credit where credit is due.

Now let's take a look back over recent history to see why it's become such a popular space. And if we look at some of the themes that we've seen in the last few years, what comes out is that we've had very strong financial markets, especially on the riskier end of the spectrum. But regardless whether in bonds, traditional equities or alternatives, it's been a good run.

And it's meant that our plan sponsors have seen very strong returns across the board. Now, here are just some of the recent headlines we've seen. Equities have been on a tear and have reached many new highs. Of course that's come back a little bit in the recent history. Magnificent Seven stocks. We're probably all tired of hearing about them.

We've seen also 2024 was dubbed by some as the year of the bond because of the strong inflows we saw in the space, which really propped up the credit markets. And for all you fans out there, Taylor Swift's concert tour was so popular that you collectively contributed more to the global economy than many small countries. So, a lot of positive tailwinds to talk about if you're an investor.

And let's look at that in more detail, what it's actually meant for on the return perspective. And what we've done here is we've broken down the last two years in a little more detail to give you a sense of how plans have done. And I recognize that not everybody listening today falls into these two brackets but allow us to use these as illustrative examples, whether not for profit clients or defined benefit pension plans  (DB pension plans).

And what we're showing you here are the returns over the last two years. You can see they range anywhere from 8 to 12%. Arguably the not-for-profit number is maybe a little conservative because of the source of the data we use, but the exact numbers aren't actually that important in this conversation. What is important is the overall theme that has been a very strong return, both in 2023 and 2024.

And I think the state of the defined benefit pension space is also a really nice area to hone in on to see how that's done on an even longer lookback period, say over the last five years. And what we do here is we hone in on that period and show you another health indicator for pension plans, which is the percentage of plans that are fully funded.

And you can see that over the last five years, there were about 30% of plans that were fully funded five years ago. And in 2024, we're now hitting 90%. And that is a really healthy jump. And that certainly jumps off the page for me. So what does this consequence have for plan sponsors if you've come off of a run of really strong returns?

Well, many plan sponsors are revisiting their asset mix. It's kind of a healthy reaction when you've seen strong moves, and it's also something that you should do on a periodic basis. And we have the pleasure of accompanying our clients on a lot of these projects. And we thought we would share some of the key questions that we're getting from clients and some of the actions they're asking themselves.

For example, the first one is, should we be derisking? We've had a great run, maybe it’s time to take some of the risk off the table. On the other hand, some people or maybe on the flip side of that saying, well, we've had a great run. We want to get to a fully funded position. Maybe we should take on more risk.

Alternatively, some clients are looking at the diversification angle and saying, well, you know, my portfolio's been pretty concentrated. Maybe I can diversify away some of that. And then lastly, on the liquidity end, this is a really interesting space, is that maybe clients have found themselves with a little too much in the illiquid bucket. They can't quite access all their cash needed to meet their benefit payments or their cash flow requirements.

And so that's triggering a review. And so these are just some of the things that our clients are thinking about. But at the high level, what's the summary? Well, markets have been very strong, clients have benefited from it, and now they're revisiting their asset mix and wondering if there's action that should be taken. So, in light of these observations, we've seen an increased demand and interest in credit.

And so let's focus on that for a little bit. We've seen a lot of trends in the credit space. And there's four in particular that stand out when it comes to the conversations we've had with our clients. Where are they going? Well, the first lot might be taking the first step, which is looking at a more comprehensive strategy of moving from a traditional core bond portfolio to one that is a core plus.

Next, we see plans allocating specifically to standalone credit strategies and really carving out a portion of their overall asset mix and creating space for credit. That could be something like a global corporate bond, a higher bond or multi-asset credit strategy. Then, there are those who are increasing the diversification within that allocation to credit. So further diversifying away from the exposure that they have today to add incremental sleeves.

And then there are those who are tapping the illiquidity risk that comes with credit. For example, tapping into private credit, which has been a very popular space. And we've seen growth in all of these segments. But we'll use one of these as an illustrative example to just show you the magnitude of the interest and the activity.

So let's hone in on the core plus base, just illustratively, to show you the growth. And if we look between 2015 and 2024, we can see a doubling of the AUM and see that it's really expressed as a very strong asset class, a lot of interest by investors and illustrative of the growth we're seeing across all four categories.

And when it comes to the different types of credits, well, there are many different types, as I alluded to, that offer different return premia and different levels of risk.

And we show you a few examples of these on the right-hand side as illustrative. What you want to take away here is that as you move to the right on this chart, you take on more risk, but arguably you should be compensated for a higher level of expected return. Now there's a variety of global credit strategies to choose from, and these most of these markets are actually much larger than what we had even in Canada.

But where they are flanked, what's interesting is that they're flanked by core bonds on the most conservative end and global equities on the riskier end. And because they fall in between, they actually can serve different purposes depending on whether you're coming from a bond allocation and allocating more to credit, or whether you're taking risk off the table from equities and allocating it to credit.

And we'll get into more on that later. But before we do that, let's talk a little more about what it's like to actually invest in credit and what it means for the investor. And so if we contrast that to something that everybody is familiar with generally is the risk premia that you get for investing in equities.

And when you invest in equities, you typically access different geographies. You might go into different sectors. You'll buy different companies. And of course, the currencies that they're underlying, that they're exposed to will also be something that you can tap into. And so the manager has a few levers to take advantage of to generate excess return or alpha as we call it in this page. But when you're a credit investor, there are actually many other levers that now come into play.

And in fact, we're showing you five others on this list that the manager can tap into to generate excess return over the target. And you can see at the bottom that credit quality and liquidity that we showed on the prior page are the ones that feature here, but they're not the only ones. And as an active fixed income manager, you can tap into these and to show you how ripe the terrain is for active management in credit.

We show you here different universes of the typical global credit strategies. We show you the global investment grade corporate bond universe. We show you how managers have done in the global high yield space, as well as the emerging market corporate debt space. These are three separate categories that are quite popular and very well represented by active management. And we show you here the range of returns in those blue rectangles.

And you can see that the index that these managers are trying to beat often plots at the bottom over a ten-year period, which means that over ten years active managers have been able to outperform and beat the index. And if we look at the median, which is the middle of those blue rectangles, the median return of global investment managers is actually solidly ahead of the index.

So even if you're in the middle of the pack for global investment you'll get corporate bonds. Let's look at what that looks like over ten years. And you can see that the manager has outperformed the index by almost 1.5% a year for ten years. So that tells us that it's been a very ripe hunting ground for asset management.

Now that we've looked at some of what the returns and the categories look like at a high level, let's look into a little more detail on some of the trends we're seeing in credit. And we're going to spotlight two of the more popular areas that we've seen, namely private credit and multi-asset credit.

Let's start with private credit because it's been a very popular space. And what is it? Well, it's just the private expression of what we get into the public space. What's different, though, is that you are lending your money directly to a borrower, but this is a private company, and you've negotiated directly with them. It's not like buying a publicly traded bond that's available for trade in the open market.

And these deals in the private credit space tend to be smaller, they’re with smaller companies that are slightly riskier. And so that come with additional risks that you're taking. And we've recreated the stack of risk premiums here that we showed you earlier. And what you see here is when you move from the public market credit space to the private market credit space, what changes? Well, there’s a little more credit risk because these issues are generally riskier. They're slightly smaller in some cases. But you're locking up your capital, so there's a lot more illiquidity risk.

Now, if we look at then what it looks like in the real market and the trade offs you're getting by taking more risk, we show you the incremental returns that you can be expected to earn.

Let's start with the U.S. Treasury bond. As of September 2024, it was yielding a 3.6% return. Now, if you move into a public market credit strategy such as multi-asset credit that we're illustrating here, you're going to be taking on more credit risk and earning a higher return. It's actually quite interesting. And you move to something closer to 8.3%.

That's an extra 4.7% that you're getting in that yellow bar for taking on more credit risk and some illiquidity risk. Now, to move to the private credit space, we see a very interesting increase in the yield that you can expect to earn an additional 3%. That comes for taking more illiquidity risk primarily.

Now, the credit quality is a little lower. So we've taken on a little more credit risk. You're locking up your capital. A lot of these private credit strategies require a lockup period. So you're limiting your access, which means you have a liquidity premium for accessing these. And finally, the fees. And these are meaningfully higher as well. In many cases, the fees on private credit strategies are 1 to 1.5% higher than multi-asset credit.

So even though private credit has been very popular, we've recommended it to many of our clients, the expected returns are certainly attractive, but they do come with some costs, and you want to keep in mind those trade offs when considering private credit. There's really no free lunch. So now let's look at private credit in the lens of not just from the fixed income space, but in the private assets bucket of typical plan sponsors, where this often gets slotted to see how it fits in there.

And if we look at it within the allocation of total private assets, you can see that the overall total portfolio allocation of private assets has increased. And you can see here that as of 2024, it represents about 40%. And it has doubled since 2012. Now grantedit’s skewed by some of the larger plans in Canada that we've surveyed here.

But it does give you a sense of the trend. And I think everybody listening would agree that this is something that we've observed.

What we've noticed, though, is that these categories do create a very large illiquidity sleeve in the overall plan. And let's be clear here, we've recommended a lot of private credit to our clients, but we are now seeing that some plan sponsors are starting to grapple with the amount of cash that is tied up in these illiquid assets and their needs for benefit payments and cash flow requirements.

And then if you look at the four of these and you think, okay, well which of these can I easily replicate in the public market space? We would argue that, you know, the private equity real estate infrastructure are a lot harder to replicate in the public space than the private credit space. So for clients who are maybe questioning the amount of capital they want to tie up in illiquid assets, we would argue that private credit might be the one that is most similar to the public, without giving up a structurally different type of investment.

So now that we've unpacked a lot of detail on the private credit space, let's now pivot to the second case study that we wanted to illustrate, which is the public market equivalent of what is popular in investing in credit, and that is multi-asset credit. And I'd like to pivot back to that risk return spectrum that we showed earlier, because what multi-asset credit does, it essentially accesses the entire spectrum of public credit assets.

It is one dynamically managed portfolio that taps into all of these different opportunities at different points of the credit cycle. By using dynamic allocations to these sleeves, depending on when it makes sense. One question that we often get from clients as well. Yeah, that's all nice and well, but why don't they just allocate to these specific allocations that I prefer,and then ride them out over the cycle? Which is certainly possible, but it does require a lot more, knowledge about these different sleeves and the selection between them.

And most of our clients don't have the luxury of being able to allocate to all of these separately. And one of the challenges too is that by allocating to individual sleeves, is you're not tapping into the possibility of actively allocating between the different segments of the global credit market. And the reason we want to emphasize that is that the performance of the different sleeves really does change dynamically year over year.

And we show you here the performance of each of these different categories that you can see in the different colours. And we show you their returns year in, year out. The strongest performers are at the top and the worst are at the bottom. And you can see that year over year, there's really no rhyme or reason between which segment will perform well, which is why multi-asset credit has been very popular because it gives you an effective way to access credit markets with one dynamically managed solution that is going to move in and out of these sleeves over time by one asset manager. You just need to make sure your manager is equipped to properly do this.

And so now that we've unpacked the two main categories that are used for credit expression by institutional plan sponsors, let's now look at how to implement this in a portfolio. So we're going to pivot our conversation to the portfolio implementation phase.

Let's quickly revisit our previous comments on what credit serves as the middle ground. Remember I said it's flanked by the core bonds and the equity sleeves. Now what's interesting about depending on where your starting point is, I'd like to think of credit as a bit of a chameleon. It can take on different roles. And so what we show you here is that if you're coming from equities and you're allocating to credit, you're actually taking risk off the table at the overall plan level.

But if you're carving it out from a core bond allocation, you're actually targeting an increased return objective. And the key point, though, is that credit can help you achieve a more optimal portfolio, regardless of whether you're a total return-focused investor or you are liability-focused. And that is a really important point that we want you to take away today. That it's useful across the board.

And so we're going to be using the public market credit expression of this, specifically multi-asset credit, as we model this in some of the implementation case studies we're going to show you here. And so on the next page, let's start with the total return-focused investor. We're going to begin with portfolio A which is a typical 60-40 portfolio, 60% traditional equities, 40% traditional bonds.

And based on our modeling and current market conditions, you can expect that to achieve a return of about 6% with a volatility of around 10%. And for those who listen to our other presentation, , you may take away that if you move to adding real assets to your mix, you then move to portfolio B, which means you've taken risk off the table, but we've assumed a similar return. Once you've added credit into the investable universe, what happens? Well, actually, you move up to the blue line, the efficient frontier, by adding credit. And in this case, the addition of credit has meant that we've increased the return for the same level of risk. But arguably you could land anywhere on that line depending on the mix of assets.

And so this is a return enhancing example, but it can actually serve both return enhancing and risk reducing, as I said, a bit of a chameleon strategy. What does that mean, though, if you're at the lower end of the risk spectrum or at the higher risk spectrum, does the answer change? And this is what I find truly fascinating. When you look here on the right-hand side, this chart may not be intuitive, but what we show here is that we're showing the optimal asset mix from a risk return perspective over different levels of risk.

We're using four asset classes: core bonds, credit, equities, and real assets. And there's the more conservative, lower risk, lower return portfolios on the left-hand side where core bonds make up the majority of the allocation. And as you move further right, you get the riskier expressions that have more equities. But regardless of the starting point and the risk tolerance, look at that green band.

The portfolio you can see always has credit. And it has a very important role regardless of your risk tolerance and enhancing the risk return profile of the portfolio. Now let's move to the last case study that we want to share. And that's looking at it from the perspective of a liability-focused investor. I promise this is the last efficient frontier that we're going to be sharing.

But when you have to keep liabilities in mind, how does that change the usefulness of credit? Now for liability focused investors, we want to show this from the perspective of a de-risking spectrum. And we show you here, this gray line that shows you points along the spectrum and clients are typically somewhere on here, whether they're at a fully de-risked, 100% liability-matching portfolio, all the way out to a 100% return-seeking portfolio.

Note that the horizontal axis, though, the volatility here is different because we're actually looking at the tracking error versus the liabilities that the plan's sponsor owes in the future. And on the return spectrum, we're showing the potential to earn excess return over the liabilities. So it's a slightly different lens that we're using here. Most plan sponsors are plotting somewhere on this risk return spectrum.

But for our example, let's say we're starting at a 50% hedge ratio, which is a mix of core bonds complemented by return seeking assets such as equities and real assets. Let's say you want to improve your hedge ratio by moving to 75%. In doing so, you're going to take risk off the table. Less volatility versus your liabilities. Good.

But you're actually going to have to give up some of the return that you can earn because you've moved into lower risk assets. And in fact here, you're moving from about 1.6% excess return over your liabilities to 0.9%. You're about halving it. Now, what if we can introduce credit strategies into the mix and we show you here that what happens if you can use or tap into a multi-asset credit, for example, what is the impact?

And our optimization shows that you don't need to give up as much return to move to a 75% hedge ratio. In fact, you're only giving up 0.2% of excess return over your liabilities. So this is just one example, but the same outcome can achieve at different points on this spectrum. The key takeaway here is that for a liability focused investor, you can improve your hedge ratio more efficiently by using credit on the de-risking path.

Now if we look at then different ways to implement it, there's a governance consideration that cannot be overlooked. As we've discussed previously, there's different ways to implement credit allocations. And some people may choose the “à la carte” method by allocating to individual strategies to tap into different areas of expertise. And the biggest benefit in these cases is that you can control your asset allocation, and you can decide which specialists will run with each of these sleeves.

But it does require large staffing resources because you need to be able to oversee these allocations, hire these managers and stay on top of them and arguably allocate between them. Most of this wouldn't be an issue if we had unlimited resources, but many of our clients are constrained with fairly resource constrained teams. So the other way you can add credit to your plan is by considering a consolidated mandate or a packaged solution.

And we show you that on the right here, for example, by tapping into a core plus bond. Or the next step is often multi-asset credit. Because it's a convenient and efficient way to access credit. You get access to multiple credit segments in one single dynamically managed portfolio. You have one investment manager that's responsible for allocating between these different segments, can tactically manage the allocation.

And this really helps alleviate the governance burden for a client, because there's only one manager to oversee. The trade off, though, is that you don't have as much customization potential with this. So a lot to think about when it comes to the expression you choose. So that wraps up our presentation today. And so before we sign off, let's recap some of the key takeaways that we wanted to share with you today.

Firstly, we're seeing clients increase a lot to credit as part of their portfolio. Whether it's because they want to de-risk, maybe they want to re-risk or they simply want to diversify. Now second point is that not all credit is the same. They're quite diverse, and they each have their unique characteristics and different degrees of risk. But importantly, credit markets are a ripe area for active management where they can generate very interesting excess return.

Credit can improve your portfolio returns to the fastest growing areas. We're seeing our private credit and multi-asset credit each have their strengths depending on what you're trying to achieve. Be mindful, though, of your portfolio's liquidity, because the extra return for taking on illiquidity risk may be attractive, but it does come at a cost. And lastly, when it comes to different implementation methods, keep in mind the governance impact and what you can take on.

So that concludes our presentation on credit. We're glad you listened in and truly hope that this was helpful. And please reach out to your PH&N Institutional contact should you have any questions. Thank you.