Hi, I have doubt from section 3.2 Active Bond management Following are the core reading: There is typically only a limited range of circumstances in which an individual bond will outperform its peers and provide a higher return than its yield-to-maturity at the point of purchase, which include: The issuer’s perceived creditworthiness being upgraded or ‘corrected’ relative to other issuers – for example, a credit ratings upgrade – resulting in an upward adjustment in the bond’s price (downgrades may be equally profitable for investors who hold short positions). There is another core reading statement after few para just before switching topic: Other areas where an active bond manager could generate outperformance include having a lower average credit rating than the benchmark or peer group (resulting in a higher yield which is hopefully not negated by higher defaults), or seeking yield enhancement by identifying the ‘cheapest’ bond from a group of similar issues having otherwise similar ratings, liquidity, size, and so on. Aren't these core reading conflicting ? At first it is said that outperformance is possible if there is upgrading (leading to bond price increase) and later core reading states outperformance is possible if there is downgrading (leading to bond price decrease). please help me in understanding how these two different core reading makes sense and are not conflicting. Thanks in advance for helping me
Hi, If we've bought a bond at a particular credit rating and a price that corresponds to the credit rating we hope that the likelihood of being repaid increases ie that the credit rating for the bond goes up. The yield on the bond will fall and the price of the bond will increase and so we can make a profit. The second point is consistent with this. It is not talking about downgrading as such but identifying bonds that have a lower credit rating than perhaps they should. In order to generate these profits we would look to identify these "cheap" bonds ie bonds with a low credit rating that are actually more likely to pay out than the credit rating would suggest. For example, if the market is pricing in a 70% chance of default but actually we believe it to be 50% then the bond is underpriced and so by buying it we may seek to profit from this underpricing. Hope this helps. Joe
