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Tactical Allocation by Credit Quality

Martin Fridson and Camille Mcleod-Salmon
The Journal of Portfolio Management Fall 2011, 38 (1) 69-77; DOI: https://doi.org/10.3905/jpm.2011.38.1.069
Martin Fridson
is a global credit strategist at BNP Paribas Asset Management, Inc., in New York, NY.
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  • For correspondence: martin.fridson@bnpparibas.com
Camille Mcleod-Salmon
is a research analyst at BNP Paribas Asset Management, Inc., in New York, NY.
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  • For correspondence: camille.mcleod-salmon@bnpparibas.com
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Abstract

Tactical asset allocators operate on the assumption that if risk premiums increase, higher-rated bonds will outperform lower-rated bonds, and that if risk premiums decrease, the reverse will happen. Empirical testing shows, however, that about 30% of the time, these expected relationships break down. Drawing on a classic debate among corporate bond market participants, investors might hypothesize that tactical asset allocators can improve their results by classifying bonds according to market-based risk premiums rather than by agency-generated ratings. In the context of tactical asset allocation, however, Fridson and Mcleod-Salmon do not find the market to be a shrewder judge of credit risk than the rating agencies. The solution to the problem of perverse outcomes in credit-oriented tactical asset allocation may be to combine top-down sector selection techniques with bottom-up security selection.

TOPICS: Portfolio theory, fixed-income portfolio management, analysis of individual risk factors/risk premia

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The Journal of Portfolio Management: 38 (1)
The Journal of Portfolio Management
Vol. 38, Issue 1
Fall 2011
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Tactical Allocation by Credit Quality
Martin Fridson, Camille Mcleod-Salmon
The Journal of Portfolio Management Oct 2011, 38 (1) 69-77; DOI: 10.3905/jpm.2011.38.1.069

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Tactical Allocation by Credit Quality
Martin Fridson, Camille Mcleod-Salmon
The Journal of Portfolio Management Oct 2011, 38 (1) 69-77; DOI: 10.3905/jpm.2011.38.1.069
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  • Article
    • Abstract
    • DEFAULT EXPERIENCE
    • RELATIVE RETURNS
    • SUCCESS RATIOS OF AGENCY RATINGS
    • EFFECTIVENESS OF AGENCY RATINGS IN TACTICAL ASSET ALLOCATION
    • SUCCESS RATIOS OF MARKET RATINGS
    • COMPARISON OF AGENCY RATINGS AND MARKET RATINGS
    • TESTING FOR A RESIDUAL TERM-RISK EFFECT
    • CONCLUSION
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