Stay Plugged In With Canon
Latest News & Updates

In practice, evaluating whether to overweight investment-grade credit versus Treasuries starts with a clear objective: what is the incremental yield you pursue, and how much risk are you willing to absorb to achieve it? Treasuries provide a safe, highly liquid base, especially in volatile markets, but their yields can be stubbornly low for extended periods. Investment-grade corporate bonds offer higher coupon income and sometimes improved total return, yet they carry credit risk and higher duration sensitivity to shifts in interest rates and economic news. The decision framework should quantify the expected incremental yield relative to the added risk, measured in terms of average credit spreads, convexity, and the probability of default within the chosen horizons.

A disciplined approach begins with a scenario-based assessment. Build baseline returns using a pure Treasury ladder and compare it to a ladder that adds investment-grade exposure in targeted sectors with favorable fundamentals. Consider liquidity implications: Treasuries are highly liquid, while some investment-grade bonds may trade less efficiently in stressed markets, widening bid-ask spreads. Evaluate sector concentration, issuer quality, and the resilience of cash flows under different macro regimes. The objective is to capture guardrails that keep potential drawdowns and displacement risk within acceptable limits while still delivering a meaningful yield uplift relative to pure Treasuries.

The first pillar in that framework is risk budgeting. Determine an acceptable maximum drawdown threshold for your portfolio within your investment horizon, and then translate that into a credit allocation that complements Treasuries rather than competes with them. Investment-grade credits tend to perform well during periods of slow growth or modest inflation, as earnings and balance sheets remain sturdy. Yet they are not immune to sectoral shocks or rate surprises, and lower-quality issues—though a minority—can drag performance. A robust risk budget uses diversification, duration controls, and selective credit research to keep downside risks aligned with the target aggregate yield.

The second pillar is duration management. Corporates often react to rate moves through shifts in both yield and price, with longer maturities amplifying sensitivity. When the yield curve bull-flattens, investment-grade credit can offer a sweet spot between spread pickup and duration risk, particularly if offered by high-quality issuers with strong covenants. In contrast, a mode of rising rates typically penalizes longer credit duration more heavily, even if the credit quality remains intact. A disciplined approach calibrates duration to maintain a smooth risk-reward profile while preserving liquidity for reinvestment opportunities.

A third pillar centers on macro scenario planning. Identify plausible states for inflation, growth, and policy that influence credit spreads and Treasury yields. If inflation cools and growth stabilizes, investment-grade spreads may compress slowly, preserving some incremental yield without a material increase in expected risk. In a backdrop of rising inflation or growth surprises, credit spreads can widen or remain volatile, adding yield but also increasing drawdown risk during sudden market dislocations. Use stress tests to gauge how your mix would behave under historical shocks and plausible extrapolations, ensuring the portfolio retains defensiveness when Treasuries rally during risk-off periods.

The fourth pillar concerns liquidity and execution considerations. Treasuries can be swapped in and out with minimal friction, and their trade execution is predictable. Investment-grade bonds, especially in less liquid corners of the market, may require careful timing and larger position sizing to avoid unfavorable fills or price slippage. Build a decision rule that governs when to add or reduce credit exposure, taking into account the bid-ask environment, fund liquidity constraints, and the cost of turnover. Transparent governance around tradeoffs helps maintain discipline and prevents drift toward yield chasing or unnecessary complexity.

The fifth pillar relates to issuer quality and diversification. Even when overweighting investment-grade credit, avoid overconcentration in a few sectors or issuers. A diversified approach reduces idiosyncratic risk and helps stabilize risk-adjusted returns relative to a purely Treasuries-based strategy. Consider sector-specific resilience, such as utilities with stable cash flows or financials with solid capital positions, but be mindful of regulatory or competitive pressures that could shift fundamentals. A well-diversified portfolio reduces the likelihood that a single credit event dominates outcomes while still delivering incremental yield compared with a Treasury-only baseline.

Complementary screening tools reinforce sound decision making. Leverage credit ratings as an initial screen but avoid relying on them exclusively, since ratings do not capture issuer-specific trajectories or market liquidity nuances. Incorporate forward-looking research on earnings quality, cash flow stability, leverage dynamics, and covenant protections. Scenario analysis should examine how each issuer’s profile shifts under different interest-rate paths and recession scenarios. By linking research insights to a clear investment thesis, you create accountability for performance drivers beyond simply chasing higher coupons.

A sixth pillar is governance and process discipline. Establish a formal framework for evaluating incremental yield that includes predefined thresholds, review cycles, and escalation paths if credit stress emerges. Decisions should be anchored in documented theses, with clear metrics for success and well-defined exit points when risk-reward propositions deteriorate. This governance reduces the temptation to chase yield in ways that distort risk profiles or escalate portfolio complexity. Clear accountability helps protect the unintended consequences of crowding into any corner of the credit market.

The role of rebalancing and cash management matters as well. Periodic rebalancing ensures the portfolio maintains the intended risk posture, while cash cushions allow timely reinvestment in response to changing spreads. In practice, a modest overweight to investment-grade credit can be adjusted as new information arrives, preserving incremental yield without overextending the risk budget. Rebalancing decisions should factor in transaction costs, tax considerations where applicable, and the evolving liquidity landscape across Treasury and credit markets. The net effect is a smoother path to the target yield objective with controlled volatility.

A seventh pillar involves cost of carry and tax efficiency. Incremental yield must be evaluated net of expenses and taxes to reflect true performance contribution. Both Treasuries and investment-grade credits incur costs—yield spreads, management fees, and potential tax drag. For taxable accounts, the after-tax yield advantage of Treasuries may differ markedly from the after-tax performance of investment-grade allocations, depending on local rules and income profiles. A precise assessment of these frictions helps avoid overstating benefits and ensures the portfolio’s advertised risk-adjusted return aligns with realized results.

Finally, translate the framework into an actionable plan with milestones. Start from a baseline Treasuries position and layer in credit gradually as conditions warrant, rather than adopting a sweeping overweight. Document triggers—for example, a minimum spread-to-Treasury level or a volatility threshold—that prompt adjustment, and specify monitoring cadence. Maintain a clear narrative about why incremental yield is expected and how it will be realized through a disciplined set of moves. An ongoing education process for investors and stakeholders strengthens trust and supports long-run resilience in both stable and turbulent markets.