How do you control credit risk?
Everything carries risk. People understand this intuitively, but they are notoriously bad at evaluating risk. For example, many folks are afraid of flying, but typically the most dangerous part of air-travel is the ride to the airport. In the same way, after Jaws came out people became much more aware of the risk of a shark-attack, but the most dangerous item in the book and the movie was the air-mattress one young boy was swimming on. Drowning kills lots more people than shark-bites.
In investing, it’s important to quantify the risks and the returns that we expect from our investments. With the Fed engaging in “financial repression,” essentially artificially supporting the economy on the backs of savers, we can’t build a Treasury bond ladder and expect real returns. But by taking prudent credit-risk, investors can maintain their income.
The key is to quantify the risk. I’d discussed in the past how credit hangs on five fundamentals: liquidity, solvency, efficiency, credibility, and growth. By watching these factors—and especially their trends—careful bond buyers can add to their returns.
Douglas R. Tengdin, CFA
Chief Investment Officer
If you have questions or comments, please write me at questions.