Optimizing a Global Credit Portfolio

By using a “building block” approach, investors may be able to improve diversification, boost risk-adjusted returns and reduce implementation costs. However, the implementation of a hybrid building block approach, in which active strategies are combined with passive and systematic, should be performed with careful consideration of each investor’s risk tolerance and goals.

Building Blocks: From Theory to Action

Data shows that fixed income investors may benefit from a “building block” approach, in which various fixed income sectors and styles — active and passive — are combined to create a bespoke fixed income exposure. We previously showed how this approach may allow investors to tilt to a higher-returning allocation without increasing tracking errors or drawdowns (see Active and Index: Fixed Income Building Blocks). In this piece, we tackle the implementation of the building block approach.

How do clients most effectively implement building blocks in practice? Like so many questions related to strategic asset allocation, there is no one-size-fits-all answer. In practice, the mix of fixed income strategies should be suited to each investor’s specific goals and risk tolerances. In this piece, we focus on the investment grade credit segment and analyze how various building blocks — active, passive, and systematic — may be combined to optimize investors’ portfolios at specific risk budgets.

The portfolio modeling example we present shows that, depending on the investor’s risk budget, there is value in allocating to passive and systematic credit strategies. These help diversify the active allocations and make the most efficient use of the risk budget, resulting in better risk-adjusted returns. An additional benefit relative to a purely active approach is a reduced cost of implementation.