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We think nothing describes our strategy better than the credit cycle chart which most, if not all, of our investors have seen at some point during the last 10 years. It is at the heart of our credit investing philosophy. It never changes; just the point where we are changes, sometimes slowly, sometimes quickly.



From an investing perspective, the positive aspect of the current environment is that, unlike 2006-2007, the major global economic forces are not in the same region of the cycle (see above). This high degree of asynchronism has been rare for the past several decades. It creates the opportunity not only for some decent real yield (although the nominal one might seem low for those of us who grew up with noticeable inflation), but also, very importantly, it creates a rare opportunity to build a more balanced credit portfolio. Ultimately this means higher quality returns.

Why is the quality, or the risk one pays for a unit of return, important? After all, we might think we do not eat risk, nor alpha, just returns. Well, it turns out that the return we eat today is the risk we took yesterday. More precisely, it is the mix of this risk and luck (or randomness). The more risk today, the more luck needed for tomorrow’s lunch.

Understanding this point is absolutely critical in credit investing. The anomaly of debt investing is that, due to the par nature of these securities, at the top of the cycle there is increasingly – and deterministically – little upside left for an increasingly larger downside; here one pays the most risk for the lowest returns. These investments have the highest negative convexity. Conversely, during the contraction, due to the seniority in the capital structure, one pays the least risk for the highest returns (so much to the ode to efficient markets).

High quality returns depend less on randomness; they need less luck, they are positively convex. This is what we aim to build in our portfolio. We cannot do so when all economies peak at the same time. Fortunately, the current environment is more conducive to balance, to higher quality. The last thing an investor wants to do today is to chase the yields of a topping cycle, either by getting deep into junk or, much much worse, levering the little upside left. The first thing an investor wants to do is to look for those niches of opportunities that still are out there in the world, unexploited and positively convex. Some might be more volatile, but they are actually less risky.

-Sorina Zahan, Ph.D.

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