What are the main credit strategies in fixed income portfolio management?

Credit strategies in fixed income aim to generate excess returns by actively managing exposure to credit risk — the risk that issuers may default or experience rating downgrades. Here are the core approaches tested on CFA Level III:

1. Credit Spread Duration Positioning

Adjust the portfolio's credit spread duration to profit from expected spread movements:

• Expect spreads to tighten? Increase credit spread duration (overweight corporate bonds, especially lower-quality)
• Expect spreads to widen? Reduce credit spread duration (shift toward treasuries)

2. Sector Rotation

Shift allocations across credit sectors based on relative value and macro outlook:

• Rotate between investment grade (IG), high yield (HY), bank loans, and emerging market debt
• Example: Late in the credit cycle, rotate from HY to IG as default risk rises

3. Security Selection (Bottom-Up)

Identify mispriced individual bonds:

• Analyze issuer fundamentals (leverage, interest coverage, cash flow)
• Look for "fallen angels" (recently downgraded from IG to HY) that may be oversold
• Avoid deteriorating credits before the rating agencies act

4. Credit Curve Strategies

Exploit differences in spread across maturities for the same issuer:

• Bullet strategy: Concentrate in one maturity bucket where spread is most attractive
• Barbell: Overweight short and long credit, underweight intermediate
• Roll-down: Buy bonds at a steep part of the credit curve and profit as they "roll down" to a lower spread

5. Relative Value Trades

• Cash-CDS basis: When the CDS spread is wider than the cash bond spread for the same issuer, buy the cash bond and buy protection via CDS to capture the basis
• Cross-sector: If BB-rated industrials are cheap relative to BB-rated utilities on a historical spread basis, overweight industrials

Example: Ashworth Fixed Income Fund expects an economic recovery. The PM increases credit spread duration from 3.5 to 5.2 years by adding BBB corporates and reduces treasury allocation. Over the next quarter, IG spreads tighten 25bp, generating approximately 25bp × 5.2 = 130bp of excess return from spread compression alone.

For the CFA Level III exam, be ready to recommend credit strategies based on a given economic outlook and justify the positioning with spread analysis. Practice in our CFA III question bank.