The Efficiency Gains of Long-Short Credit Strategies

Abstract

The potential efficiency gain associated with long-short active strategies compared with long-only active strategies has been known for some time as it applies to equity portfolios. Owing to recent developments in the fixed-income market, long-short strategies can now be used for credit risk selection. This article reviews the framework and assumptions for assessing the potential efficiency gains for long-short investment-grade credit and high-yield credit strategies compared with the efficiency gains for long-short equity. Despite differences in benchmarks and in security-specific risk and portfolio risk characteristics, the expected efficiency gains for long-short credit strategies are demonstrated to be similar in magnitude to those previously found for long-short equity strategies. This has important implications for how investors should structure fixed-income portfolios to exploit these efficiencies.