Tactical Financial Solutions: Strategies for Credit Management and Improvement
Tactical credit strategies offer a unique blend of income generation, capital appreciation, and risk management by dynamically adjusting exposure between high yield corporate bonds and core fixed income. These strategies aim to capitalise on favourable credit environments while preserving capital during risk-off periods.
Key Performance Characteristics
Tactical credit strategies seek enhanced income from high yield corporate bonds, which carry higher credit risk and offer higher yields, during favourable credit environments. Conversely, they shift to core fixed income, typically investment grade credits and government bonds, to preserve capital during risk-off periods.
Risk management is a key focus of these strategies. By tactically reallocating between sectors, the strategy manages credit spread risk and interest rate sensitivity more actively than static bond allocations, aiming to reduce volatility and downside risk while capturing opportunities from credit spread dislocations and yield curve shifts.
These strategies are often managed as total return funds, combining current income with capital appreciation by exploiting relative value, event-driven, and macro-driven credit opportunities.
Contributing Factors to Performance
The performance of a tactical credit strategy is heavily influenced by the credit cycle and spread behaviour. Tight spreads limit the upside from high yield exposure, while widening spreads create downside risk but may provide tactical entry points.
Changes in interest rates also impact the strategy's performance. Active managers can adjust duration to mitigate interest rate volatility and exploit relative value moves.
Credit quality and default rates vary by sector and economic cycle. Tactical strategies must weigh elevated defaults against spread compensation.
Macro and sector dynamics play a crucial role in the strategy's performance. The ability to apply a top-down macro view combined with bottom-up credit analysis allows the exploitation of event-driven or special situation trades and sector rotation, helping to capture alpha.
Tax considerations can enhance after-tax returns if the strategy incorporates municipal bonds or tax-advantaged instruments, depending on the investor’s tax situation.
Success depends on the manager’s skill in credit research, market timing, and sector allocation, as active strategies can navigate volatility and identify relative value inefficiencies beyond benchmark constraints.
Summary
A tactical credit strategy that switches between high yield corporate bonds and core fixed income blends the higher income and risk of high yield bonds with the stability and lower volatility of core fixed income. Performance tends to reflect the manager’s skill in timing market cycles, managing credit and interest rate risks, and identifying relative value across sectors.
The tactical credit strategy tends to outperform core bonds during most periods, but underperforms high yield corporates in most environments. The ensemble strategy's price return and total return series return 2.1% and 2.9% annualized respectively, implying that capturing price return effects account for approximately 75% of the strategy's total return.
The tactical credit strategy's momentum signals are significant only for formation periods from 3-to-5 months and holding periods where the total period (formation plus holding period) is less than 6-months. The cost of carrying this tactical position is rather expensive and places a larger burden on the strategy accurately timing price return.
Financing these strategies requires careful consideration of the manager's skills in credit research, market timing, and sector allocation, as performance largely depends on these factors.
Investing in a tactical credit strategy offers the potential for increased income and capital appreciation through dynamic exposure between high yield corporate bonds and core fixed income, despite the cost and the necessity for accurate timing.
