@Ardea Investment Management.
Compensation for credit risk is key to the value proposition of corporate bonds because investors need to balance the trade-off between the potential for higher returns versus the additional downside risk. Focusing on investment grade (IG) corporate bonds specifically, the compensation for bearing credit risk has dropped to historically low levels. Even if one is positive on credit fundamentals, the risk/return trade-off is now asymmetrically poor, offering limited upside from further spread compression versus the risk of large downside in adverse scenarios. UK government bond yields are also at historic highs, making UK gilts more attractive than credit. However, caution is key. Falling interest rates, geopolitical tensions, shifting fiscal policies and heightened volatility in fixed income markets can impact expectations for forward looking asset class returns. Default rates in investment grade credit remain low, but market dynamics demand vigilance.
Relative value strategies present a compelling alternative. By exploiting pricing inefficiencies in government bond markets, they generate uncorrelated returns, improve diversification, and reduce exposure to broad market risks. Unlike corporate bonds, they offer defensive characteristics in both risk-on and risk-off environments. Adding relative value strategies to insurers traditional core fixed-income portfolios offers reduced market direction sensitivity, effective diversification, and resilience in both risk-on and risk-off scenarios.
