Credit investing plays an important role in the financial markets by channeling capital to companies and governments. However, investing in individual bonds can expose investors to significant credit risk. Systematic credit investing aims to minimize this risk through diversification across a broad range of issuers, sectors and geographies. By using quantitative models and rules-based methodologies, systematic credit strategies construct diversified bond portfolios targeting specific risk-return objectives. This approach harnesses the power of credit markets while controlling for credit risk factors.
Diversification reduces exposure to individual issuers
Investing in individual corporate bonds exposes investors to significant credit risk arising from the possibility of default by that issuer. For example, investing solely in bonds issued by a single company means losing the entire investment if that company goes bankrupt. However, holding a portfolio diversified across hundreds of corporate bond issuers minimizes the impact of any single bankruptcy. Systematic credit portfolios are constructed to limit exposure to individual issuers, typically capping any single issuer at 1-2% of the overall portfolio value.
Sector exposures are constrained
Overexposure to any single economic sector also creates concentrated credit risk for bond investors. The energy sector provides a stark example, as periods of low oil and gas prices can strain many issuers simultaneously. Systematic credit strategies control sector exposures through portfolio constraints, ensuring diversification and avoiding unintentional sector bets. The portfolio construction process balances exposures across sectors based on the investment universe and risk objectives.
Global diversification reduces systemic risk
Concentrating investments in a single country or region may expose investors to systemic credit risk specific to that area’s economy and policies. For example, portfolios limited to European issuers would underperform when the Eurozone economy struggles. Systematic credit investing diversifies globally, incorporating bonds from issuers across North America, Europe, Asia and emerging markets. This global approach to credit investing helps insulate against localized downturns and takes advantage of divergent economic cycles.
Quant models forecast risk and return
Systematic investing relies on quantitative models to forecast risk and return for individual bonds. By examining factors like leverage, volatility and yield spreads, the models identify bonds likely to outperform or underperform. Portfolios are constructed to emphasize bonds with attractive risk-return profiles while limiting exposures to potentially troubled issuers. This model-based approach provides discipline and objectivity to the credit selection process.
Systematic credit investing uses diversification and quantitative models to reduce exposure to individual, sector and geographic credit risks. Constructing diversified global bond portfolios helps generate attractive risk-adjusted returns from credit markets while avoiding unintended risk concentrations.