Defined benefit (DB) pension schemes are holding back from increasing allocations to credit despite heightened market volatility, as persistently tight spreads limit attractive entry points, according to BNP Paribas Asset Management.

Speaking to Pensions Age, BNP Paribas Asset Management senior portfolio manager, Rob Price, said recent geopolitical tensions - particularly the conflict involving Iran - have driven significant volatility in interest rate markets, but have had a more muted impact on credit.

“March has been dominated by geopolitical developments and the impact on markets.

“That’s caused huge volatility in fixed income markets, particularly from an interest rate perspective. But credit spreads have not really shifted.

“For DB schemes, because they hedge out the majority of their interest rate exposure, I wouldn’t expect a huge impact on funding levels,” he added.

However, BNP Paribas Asset Management co-head of investment specialists, fixed income, Bruno Bamberger, noted that the lack of movement in credit spreads has constrained investment activity, with schemes reluctant to deploy capital at current valuations.

“Clients do want to add more into credit, but the restriction is the level of spreads,” he stated.

“The expectation was that with volatility, spreads would widen - but that hasn’t really been the case.”

Instead, he said schemes are preparing to act when more attractive opportunities arise, with many building frameworks to enable quick deployment when spreads eventually widen.

At the same time, demand from other investor groups - including defined contribution (DC) schemes, local government pension schemes (LGPS) and retail investors - has helped support credit markets, limiting spread widening.

“Other buyers are coming in and looking at the all-in yield rather than just spreads,” Price explained.

“That’s helping to keep spreads relatively tight.”

The current environment is also influencing broader strategic decisions, with a shift away from buyout activity towards running schemes on for longer.

Price suggested that tighter spreads, alongside growing recognition of the benefits of retaining schemes, including the potential for surplus extraction, have contributed to a slowdown in buyout volumes.

“It’s not a given that schemes want to offload risk anymore,” he argued.

“There can be fairly significant benefits from running on.”

This shift is beginning to reshape portfolio construction, with schemes adopting a longer-term investment horizon and exploring a broader range of fixed income assets.

“We don’t think there will be a wholesale move back into equities,” Price noted.

“But within fixed income, you may see greater use of semi-liquid assets, such as asset-backed securities or certain types of private credit.”

The experts said that asset-backed securities (ABS) in particular are gaining traction, offering a balance between yield enhancement, liquidity and diversification.

“These are high-quality assets that can provide additional spread without taking on undue risk,” Bamberger said.

“We’re seeing increased interest from DB schemes looking to enhance returns within a de-risked framework.”

In addition, some schemes are shortening duration and holding “dry powder” to remain flexible in the face of ongoing uncertainty.

“In times of tight spreads and uncertainty, reducing risk and being prepared to reallocate when opportunities arise is key,” Bamberger added.

Despite geopolitical risks, both speakers emphasised the importance of maintaining diversified, resilient portfolios, noting that many current market drivers are not rooted in corporate fundamentals.

“These are risks driven by geopolitics rather than fundamentals,” Price warned.

“That makes diversification and credit research even more important.”

Looking ahead, both said they expect credit spreads to remain relatively tight in the near term, supported by strong corporate fundamentals and continued demand from a broad range of investors.

“Credit spreads are at the tighter end of the range, but that reflects the strength of company fundamentals and technical demand,” Bamberger stressed.

“It will likely take a more significant event to drive spreads materially wider.”

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