Credit Strategies for Tactical Advantage
In the world of investment, a tactical credit strategy has emerged as a potential game-changer, particularly during periods of expanding credit spreads above their long-term median level. This strategy, employed by financial giants like JPMorgan, aims to capitalise on the difference in performance between high yield and core bonds, both in terms of price returns and carry (yield) differences.
At its core, a long/short credit strategy involves taking long positions in assets expected to appreciate and short positions in assets expected to depreciate. The goal is to profit from the difference in performance between these two sets of assets.
The strategy's focus on price return differences involves identifying undervalued or overvalued assets based on market mispricings. On the other hand, the carry component aims to exploit yield differences, such as holding higher-yielding bonds and shorting lower-yielding ones to profit from the spread between the two yields.
JPMorgan's Strategic Income Opportunities Fund, for instance, incorporates a long/short credit book that combines traditional and derivative credit positions, including investment-grade and high-yield bonds. However, specific details on the breakdown between price return and carry yield differences are not publicly available.
The active returns of the portfolio are generated by tactical signals, providing value-add beyond a diversified buy-and-hold core. The strategy also benefits from harvesting net carry differences between high yield and core fixed income, accounting for approximately 25% of strategy returns.
The strategy tends to thrive in crisis periods, such as 2000-2003 and 2008-2009, where it harvests almost all of its returns. In fact, since 1996, the strategy has harvested approximately 35,000 basis points, with a majority of the benefit coming from harvesting contracting spreads.
Interestingly, the price return of high yield bonds has annualised at -0.8% since the 1990s. Removing the 2000-2003 and 2008-2009 periods significantly reduced the strategy's ability to harvest these credit spread changes.
In non-crisis periods, the strategy tends to underperform high yield corporates, but adds significant value in periods of economic stress. Capturing price returns due to changes in credit spreads accounts for approximately 75% of the strategy's total return.
The strategy can be thought of as a combination of a fixed-mix of 50% high yield corporates and 50% core bonds, and a dollar-neutral long/short portfolio that captures the tactical bet. The stability of momentum signals for the tactical credit strategy is evaluated by varying formation period and holding period of the momentum rotation strategy.
In post-crisis environments, the strategy generates yields in excess of one standard deviation of the full-period sample, equating to a 1.5% annualised excess return above a 50/50 portfolio. The significant region for the tactical credit strategy is formation periods from 3-to-5 months, with holding periods where the total period (formation plus holding period) is less than 6-months.
The tactical credit strategy tends to outperform core bonds during most periods, with the exception of periods of economic stress. Removing the 2000-2003 and 2008-2009 periods increased the proportion of total return explained by net carry to 50%.
In conclusion, JPMorgan's tactical credit strategy offers a unique approach to investment, leveraging both price return and carry differences to generate returns. While specific performance breakdowns may not be publicly available, the strategy's potential to thrive during periods of economic stress makes it an attractive option for investors seeking to diversify their portfolios.
Investing in JPMorgan's tactical credit strategy can be a business move, as it aims to capitalize on differences in price returns and carry (yield) between high yield and core bonds. The strategy, followed by financial giants like JPMorgan, employs a long/short credit strategy that involves taking long positions in assets expected to appreciate and short positions in assets expected to depreciate.
