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Today’s fixed income allocators face a variety of challenges: still-low interest rates, tight credit spreads, increased market fragility, and ever-present liquidity concerns. Growing investor liabilities and spending needs demand reliable fixed income diversification and a more consistent portfolio return profile.
We believe an outcome-oriented, “all-weather” credit (AWC) approach that encompasses public, private, and alternative credit investments may help allocators meet these challenges and navigate a wide range of economic and market environments, including unexpected cycles and bouts of volatility. In our view, such an approach to credit investing can enable investors to potentially earn attractive total returns during periods of tight spreads, while remaining positioned to take advantage of market dislocations, exogenous shocks, and shifts in the credit cycle — in short, a durable credit portfolio that is robust and resilient enough to “weather” the inevitable ups and downs of credit investing.
Foundational principles of an all-weather credit approach
How to design and construct such a portfolio? By using the building blocks of diversified public credit, private credit, and long/short credit, we believe asset owners can most effectively capture the greatest risk premia1 in the most predictable fashion throughout the different stages of the credit cycle. This is important because credit investing, by definition, seeks to achieve total returns by harnessing risk and (at times) liquidity premia — spreads and returns that are higher, ideally meaningfully higher, than realized losses. These premia are dynamic by nature, moving through various credit sectors and frequently changing in scope and scale over time (Figure 1).
At the highest level, we suggest that allocators adhere to the following guiding principles when setting out to build an AWC portfolio:
- Identify your credit allocation’s goals: First and foremost, we believe it’s critical at the outset to clearly and realistically define your credit allocation’s long-term goals and objectives, including…
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1A risk premium is the investment return an asset is expected to generate in excess of the risk free rate of return, as typically represented by US Treasury bills.