The Big MAC - Aon

The Big MAC
Multi Asset Credit -
The simple way to
access credit markets

1 Global Investment Consulting
Summary
Has the long-awaited secular rise in interest rates finally
started? How should investors reposition their corporate
bond portfolios to avoid capital losses and achieve a decent
return over cash?
There is a myriad of choices, which we detailed in our
previous papers*:
• Investment Grade Corporate Bonds.
• High Yield Corporate Bonds
• Loans
• Asset Backed Bonds
• Emerging Market Bonds
Pick one, pick two, or pick them all!
Just as a visit to the Golden Arches can leave a hungry diner
confused by the multitude of burger based meal choices,
the same can be said for yield hungry credit investors. But
with careful attention to the menu, investors should find
something to satisfy.
(*) Give Me Credit! (October 2012) and Derisking when yields are low
(November 2012).
A Clear and Present Danger
A survey of managers at our annual Aon Hewitt manager
conference highlighted Investment Grade Corporate Bond Funds
as the asset class most likely to perform poorly this year (apart
from gilts).
Why is this?
• If gilt yields rise back to their 10 year average, corporate
bond portfolios could fall around 15%.
• Even if the rise in yields is mitigated by credit spreads
narrowing to 10 year record levels, the loss would still be
over 10%
The recent rise in government bond yields has brought this
simple maths to the attention of investors and current Lipper data
shows that outflows from corporate bond funds are now close to
record levels.
What to do?
The answer is to invest in funds which focus primarily on credit
risk, rather than funds which mix credit risk and interest rate
risk together.
But which one?
The table (overleaf) shows that no one credit asset class has
consistently outperformed the others. Performance has been
adjusted to show excess returns over LIBOR cash rates (thereby
stripping out the impact of duration).
The answer is an active fund that can tactically shift allocation
between various credit classes. This could include funds that
allocate between just a few asset classes or funds that can invest
across the whole credit universe.
The Big MAC
Credit Asset Class 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
Investment Grade
Corporates
-0.65 2.32 1.31 0.19 0.48 -2.14 -13.92 10.38 0.67 -4.18 7.13 2.05
High Yield -15.33 22.45 9.39 3.61 8.12 -4.55 -42.91 61.59 10.34 -7.10 18.02 5.11
Sub Financials -0.52% 3.42% 2.03% 0.72% 0.85% -4.21% -28.74% 19.16% 1.35% 14.53% 23.78% 5.01%
ABS n/a n/a 0.40 0.56 0.52 -7.49 -46.68 8.82 21.82 -5.69 15.76 5.19
Loans n/a 1.45 3.29 3.69 3.34 -4.81 -34.44 42.51 9.27 -0.48 9.40 6.06
Emerging Market
Corporates
-14.14 11.76 5.48 3.83 2.54 -4.69 -31.75 39.27 6.36 -4.15 12.31 -0.45
Key Best Performing Worst Performing
Source: ML Lynch Data (EN00, HEAD EBSU) 30/06/2013, Credit Suisse Loan (Credit Suisse Western Europe)
and Barclays ABS (ABS Bond Index ex AAA) 31/12/2012. Merrill Lynch returns are excess returns over swaps
(no duration). Floating Rate Loans and ABS are total returns excluding Euribor

Global Investment Consulting
2
There are many funds that fall under the MAC moniker. They can
range from simple combinations of a few closely related asset
classes, such as High Yield and Loans as outlined below, through
to funds that invest across the whole spectrum of credit asset
classes - outlined later in this paper.
Manager approaches can vary from a focus on delivering credit
beta, through to ambitious LIBOR- plus targeted funds.
What is common to them all is a keen focus on credit spreads and
a low, if any, reliance on duration and currency to achieve the
target return.
Combined High Yield and Loan Funds:
Both High Yield and Loans can be attractive asset classes:
But Which one?
• Loans are generally more senior and have better recovery
rates should they default; but they can be illiquid, particularly
in Europe.
• High Yield bonds are usually the next step down in the
seniority of the capital structure and offer greater liquidity,
but the recovery in default is lower and they are sensitive to
changes in bond yields.
However, the similarities are greater than the differences:
• Both are driven by bottom up credit analysis and
default avoidance.
• Often the issuers are similar, or even the same, since much
of the universe is the result of leveraged buy-outs
Global High Yield and Loans Market ($2.6 Tr)
Full Spectrum Multi Asset Credit
As one credit asset class cannot provide the best returns all of
the time, active allocation MAC strategies are needed. These
portfolios allow managers access to more tools with a wider
freedom to seek best in class returns throughout the credit cycle.
Rather than focus primarily on bottom-up stock selection the
manger is challenged to combine these skills with a top-down
macro view to ensure effective sector rotation within the credit
universe of developed, and increasingly, of emerging economies.
In times of economic expansion, when corporate earnings are
strongest, a manager could choose to allocate to higher credit
beta sectors such as High Yield and Loans, and in times of
economic downturn seek the protection of the stronger balance
sheets offered by Investment Grade companies.
Neither Filet o’ Fish nor Fowl McNuggets
Investors need to know where MAC should be on their menu.
As a new style of investing, albeit using established sub-asset
classes of credit, it can be confusing as many features will be
used in other strategies. So having outlined what MAC strategies
should do it’s worth clarifying what they are not, and what they
should not do.
• They are not Absolute Return Bond Funds, they do not focus
on seeking alpha from duration or currency positioning.
• They do not cling to the yield curve and riding the fair-wind
of a positively sloped yield curve and, until recently at least,
falling bond yields.
• Although they may be active users of derivatives such as
credit indices and Exchange Traded Funds to control sector
exposures,they are not Hedge Funds. They do not use
leverage or go short.
US Loan Market
Global Credit Market ($9.0 Tr)
US High
Yield Bond
Market
European
Loan Market
High Yield
European High
Yield Bond Market
Loans
Investment
Grade
In Europe especially, markets are becoming increasingly
integrated as issuers switch between loans and high yield
depending on market conditions. Much of the new High-Yield
issuance seen recently in Europe has been ‘senior secured’,
ranking it pari-passu with loans.
The Big MAC
So what are the advantages of combining the two asset classes in
a single fund?
• A bigger market which maximises diversification and provides
a bigger opportunity set from which managers can select
their best investment ideas.
• Pricing inefficiency caused by individual asset class flows can
create over, or under valuations between loans and high-yield
that the manager of a combined portfolio can exploit. Often
these opportunities occur within the same company.
Emerging
Market Corporates
Conclusion
Source: Barclays, S&P and Credit Suisse
MAC funds primarily seek to receive income from managing
credit beta. Either from a simple combination of a few credit
classes, or from more complex combinations of global credit beta.
Where possible, they should also seek opportunities to invest
both up, and down, company capital structures.
Longer term, credit markets are likely to become a bigger part of
the investable universe. The effects of banking disintermediation
are already starting to be seen and the on-going deleveraging by
the banking sector will accelerate this.
This dynamic at a time when investors are rightly questioning the
risks that passive duration exposure in growth portfolios pose
should focus more attention on credit asset classes and seek ways
to combine them to meet their investment goals.

Contacts
Birmingham
Mike Johnson
0121 262 5076
michael.johnson@aonhewitt.com
St Albans
Darren Kidd
01727 888 670
darren.kidd@aonhewitt.com
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Kate Charsley
0117 900 4414
kate.charsley@aonhewitt.com
Asset Allocation
Lucinda Downing
020 7086 9440
lucinda.downing@aonhewitt.com
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Kenneth Ettles
0131 456 6426
kenneth.ettles@aonhewitt.com
Delegated Consulting
Paul Carne
020 7086 9042
paul.carne@aonhewitt.com
Farnborough
Peter Jackson
01252 768 035
peter.jackson@aonhewitt.com
Manager Research
Steve Sawyer
020 7086 9286
steve.sawyer@aonhewitt.com
Leeds
Tim Manuel
0113 291 5038
timothy.manuel@aonhewitt.com
Risk & Modelling
Yves Josseaume
020 7086 9157
yves.josseaume@aonhewitt.com
London
Sophie Moore
020 7086 9209
sophie.moore.3@aonhewitt.com
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