Strategic Credit Solutions: Financial Manipulation at Its Best

Tactical Credit Strategy Leverages Momentum for Enhanced Returns

A tactical credit strategy that uses momentum-based signals to rotate between high yield corporate bonds and core fixed income has been designed to boost returns by adjusting exposure in line with market trends and credit conditions. The driving force behind this strategy is the momentum effect, which suggests that assets showing strong recent performance tend to continue performing well in the short term.

Performance and Driving Forces

Enhanced returns in trending markets: Momentum strategies, like this credit strategy, tend to perform well in sustained bull markets or markets with clear directional trends. In credit, switching to high yield during positive momentum phases can capitalize on spread tightening and better carries, while shifting to core fixed income defensively during negative momentum helps preserve capital.
Volatility and market sensitivity: Momentum-driven asset rotation can struggle during highly volatile or sideways credit markets where whipsaws and trend reversals are common, potentially causing higher turnover and transaction costs that dampen net returns.
Risk management through allocation shifts: By dynamically shifting between high yield and core fixed income, the strategy balances credit risk and duration risk. High yield typically offers higher carry but greater credit and liquidity risk, whereas core fixed income provides more stability and income generation during downturns or slowing growth.
Yield environment and interest rate impact: The current fixed income markets, featuring higher yields and steep yield curves, can help offset potential losses from rising rates and provide a buffer for fixed income portfolios. This environment enhances the strategic value of tactical asset allocation based on momentum signals, enabling capture of income when conditions are favorable and better downside protection otherwise.
Empirical evidence of momentum strategy efficacy: Momentum strategies across equities and credit sectors have been shown to rank strongly in performance during recovery or growth phases. In fact, a momentum strategy ranked in the top 4% for 2024 performance related to equities, which may translate analogously to credit sectors depending on credit cycles.

Key Findings

The strategy tends to outperform core bonds during most periods, with the exception of periods of economic stress.
The price return of high yield bonds has annualized at -0.8% since the 1990s, reflecting defaults within the portfolio offset by recovery rates.
The tactical credit strategy is a rotational strategy between high yield corporate bonds and core fixed income, which can be thought of as a combination of two portfolios: a fixed-mix of 50% high yield corporates and 50% core bonds, and a 50% exposure to a dollar-neutral long/short portfolio that captures the tactical bet.
The strategy's returns appear to be primarily generated during times when credit spreads are above their long-term median.
The ensemble tactical credit strategy has harvested approximately 35,000 basis points from 12/1996 to present, benefiting from harvesting contracting spreads.
The ensemble tactical credit strategy was created by calculating the target weights for all possible combinations of formation and holding periods and averaging them together.
The strategy's long-run average yield is positive, representing the ability to capture carry differences between high yield and core bonds.

In summary, a momentum-based tactical credit strategy leverages price trends to switch exposure between high yield and core fixed income to maximize returns and manage risk. Its performance is typically strong in bullish or trending environments where momentum signals are reliable, but it faces challenges during volatile or non-trending phases. The yield and credit spread environment, combined with interest rate dynamics, influences its overall effectiveness.

Business applications of the momentum strategy: The application of momentum-based strategies, such as the tactical credit strategy, is beneficial for businesses seeking enhanced returns in their investment portfolios, particularly in trending markets. This strategy can help capitalize on moments of strong market trends by adjusting exposure and aligning investments with current market conditions.
Financial impact of risk management: With dynamic allocation shifts between high yield and core fixed income, this strategy manifests effective risk management by balancing credit and duration risk, providing a stable income during downturns or slowing growth, while also offering higher carry in favorable conditions. This balance is financially beneficial for businesses looking to generate income and manage risks within their investment portfolios.