Why Credit Deserves a Strategic Allocation in a Long-Term Portfolio

A frequent question from investors today is: ‘Should I still invest in credit, given that spreads are near historic tights?’ The concern is understandable, but may overlook the broader opportunity set.

If credit markets are trading at or near all-time highs, it’s likely that other asset classes in a typical diversified portfolio are also performing strongly. The conclusion shouldn’t necessarily be to reduce credit exposure or go to cash. On the contrary, we believe that credit is precisely the asset class that justifies being held as a strategic, long-term allocation, rather than tactically traded in and out.

The Structural Appeal of Credit

Credit aims to offer a strong carry profile. Take, for example, a diversified basket of BB-rated bonds in EUR currently yielding around 4.5% with a five-year maturity. Even assuming a conservative 30% recovery rate, such a portfolio would need a cumulative default rate above 32% over five years before investors would face any capital loss at maturity. While no investment is without risk, this scenario is considered unlikely in the BB space when managed with care and diversification. RAM AI’s flagship credit strategy, RAM Strata Credit, exemplifies this discipline—it has not experienced any default to date, reflecting our focus on rigorous issuer selection and a robust credit risk management framework.

Fast Recovery Profile

One of credit’s most underappreciated strengths is its potential to recover from periods of market stress within a relatively short time frame. As illustrated by the charts below, representative BB and BBB indices have historically tended to recoup their losses within two years, and in some cases, much sooner.

Moreover, active portfolio management can shorten recovery periods, as demonstrated by the RAM Strata Credit Strategy during the 2022 drawdown:

• Peak: January 2022
• Trough: October 2022
• Recovery: December 2023
• Total recovery time: 708 days

This highlights the potential benefits of proactive credit selection and tactical repositioning during volatile phases, even within a long-term allocation.

Why Focus on BBB/BB?

We believe BBB and BB credit can offer the best risk/reward in a long-term allocation strategy:

1. Less sensitivity to rates: Unlike higher-rated bonds (e.g. A or AAA), credit in this segment tends to benefit less from rate compression and more from spread compression and carry, which can offer more resilience in changing rate environments.
2. More resilient than pure high yield: While B and CCC-rated bonds can offer higher yields, they are in general more exposed to default cycles, which can extend recovery periods and increases volatility.

Conclusion: Credit Is not a Tactical Trade

Credit should not be seen as a tactical allocation driven by short-term spread moves. Instead, its carry, resilience, and potential for rapid recovery profile make it a cornerstone of long-term portfolio construction.

Vincent Ollivier

Credit Portfolio Manager

Disclaimer

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