Download the PDF version of this insight
Following the Great Financial Crisis (GFC), regulators have worked to build a framework of laws designed to limit the emergence of market conditions like those that contributed to the GFC. These laws, such as the Dodd-Frank Wall Street Reform and Consumer Protection Act, reduced the appetite for risk taking for many market players, and helped to create the credit market liquidity mechanisms of today.
Against this backdrop, which continually evolves with each episode of market stress, an active and deep credit approach may capitalize on select opportunities. A focused credit investment thesis that identifies idiosyncratic opportunities across a broad set of credit sectors expands the potential for alpha-generating ideas.
Andrew Fox: At its core, the GFC was driven by that original sin of finance: asset and liability mismatching. Banks by their nature generally fund longer-term lending with short term deposits. When credit markets ceased to provide liquidity, market participants such as banks, which financed investments through borrowings, were forced to unwind positions in a disorderly fashion. This same dynamic, similar in nature if different in detail, plays out periodically; two recent examples include the pension crisis in the United Kingdom (UK) in 2022 and the regional banking crisis in the United States (U.S.) in the spring of 2023.
Regulators continue to adjust rules to limit, if not avoid, these episodes. On the horizon is Basel III Endgame, which is the most recent update to the regulations developed by the Basel Committee on Banking Supervision. Basel III Endgame includes far-reaching changes to banks’ risk-based capital frameworks. Potential changes to Securities and Exchange Commission (SEC) Rule 22e-4, which pertains to liquidity risk management programs adopted by 40-Act mutual funds, are also forthcoming.
Capital markets have adapted to these changes, but not without major modifications. One of the largest has been well-exploited by investors, particularly in the institutional space—the rise of private credit. Borrowers have many reasons for seeking to place their debt privately, but one of the most significant may be the unwillingness of traditional banking channels to extend credit at a level and with terms borrowers find attractive.
Fox: What’s different between 2020 and today is that, while regulatory and legislative efforts globally have limited the amount of risk financial institutions hold on their balance sheets, chiefly through higher capital charges, the impact has been somewhat blunted by a historically prolonged period of low rates. With the apparent ending of ZIRP (zero interest-rate policy) the impact of restrictions, current and proposed, may be more fully felt. Additionally, with competition for depositor dollars from higher-yielding options such as money markets and the Fed’s continued quantitative tightening, banks may become even more reluctant to hold debt on their balance sheets.
For banks, the implications go beyond limiting further purchases and may extend into outright sales of existing holdings, including those originally earmarked to be held to maturity. Some of those asset sales will take creativity on behalf of buyer and seller and will in many cases be difficult for traditional fixed-income investors to participate in. Taken together, this represents both a curtailment of demand and a meaningful source of potential supply of fixed-income instruments.
Fox: Clearly, the appetite for rolling back the regulatory framework is low, given the current queue of scheduled and proposed changes. We think the new liquidity regime will remain.
One way to potentially take advantage of this landscape is to do what private credit investors have done: step into the shoes of market actors who have, for reasons already discussed, stepped away. Traded credit offers opportunity as well. With the right structure and the right investors, strategies can provide liquidity to market participants when periods of dislocation or capital shortages occur, acting in a sense as the new risk intermediary.
There are several ways to do this, and there’s no shortage of strategies standing up to try to capture one part or another of this dynamic. Some are focused on pricing dislocations—generally at a market or asset-class level—and offering capital during periods of stress to reap the benefits as markets “normalize.” Others are focused purely on liquidity premiums—building a portfolio of off-the-run instruments and hoping to capture liquidity premiums over time. Each of these approaches has its merits, but they tend to be dependent upon macroeconomic catalysts or sector/asset class specific dislocations that may be sporadic and limit the opportunity set.
We believe an optimal approach is to narrowly focus on specific instruments, specific investments, and specific stories, while viewing the dislocation as setting the table for opportunity, but not representing the central thesis for investment. The appeal of this investment-by-investment strategy is the broadening of the opportunity set that is evergreen rather than episodic. By focusing down to the line-item level, opportunities within a sector, an industry, an asset class, or a company, become much more frequent. There is also the added benefit of not basing a thesis around a macroeconomic outcome or seeking to benefit from a broad mean reversion within a sector or asset class. Instead, the investment thesis focuses on the specific structure of the security or company. The macro role, again, is limited to being an additional factor toward setting the valuation table.
Fox: We believe opportunistic credit can enhance an investment program in several ways. First, as a complement to private credit, we believe opportunistic credit is a great fit philosophically, as well as practically. Philosophically, the investor has already allocated to a space, which was also once dominated by banks, to directly capture value. Opportunistic credit strategies allow the investor to step in where traditional holders of risk, such as the capital markets desks at investment banks, or more recently the balance sheets of regional banks, have stepped away or have been forced away by regulatory capital pressures.
In addition to feeding from the same vacuum of competition, opportunistic credit complements private credit in a practical sense because private credit, by design, does not trade or price actively. In contrast, opportunistic credit strategies have an eye toward early monetization of good investments as the investment thesis plays out. While strategies should hold securities that are deemed attractive to maturity, it is also appealing to have the option to realize a gain and recycle the capital into a new idea when the market has caught up to your views.
As part of an overall asset allocation, credit may also provide diversification benefits to equity risk, especially in a new, higher rate and inflation environment. Credit has historically diversified rate risk by remaining negatively correlated to rates. In this sense, the role of credit becomes even more significant in terms of earning a strong return but with a lower level of risk than equities, as measured by standard deviation. Credit may also provide access and exposure to different risk premiums and sources of return, especially in a strategy that seeks idiosyncratic opportunities without the constraint of a benchmark. If you think about it simply as “who gets most of the cash flows?”—for years that was titled toward the bottom of the structure due to the rate environment. That has changed—noted earlier possibly for good—if the last 23 years turn out to have been an aberration. With the internal rate of return (IRR) opportunities we’re seeing in fixed-income markets, credit is making a very strong case for recapturing some of the allocation weights it lost during ZIRP.
Unless otherwise noted, all discussions are based on U.S. markets and U.S. monetary and fiscal policies.
Asset allocation or diversification does not guarantee a profit or protect against loss in declining markets.
No investing strategy can overcome all market volatility or guarantee future results.
The value of investments and any income from them is not guaranteed and may fall as well as rise, and an investor may not get back the amount originally invested. Investment decisions should always be made based on an investor’s specific financial needs, objectives, goals, time horizon, and risk tolerance.
Market forecasts and projections are based on current market conditions and are subject to change without notice. Projections should not be considered a guarantee.
Equity Investing Risks
The value of investments in equity securities will fluctuate in response to general economic conditions and to changes in the prospects of companies and/or sectors in the economy. While growth stocks are subject to the daily ups and downs of the stock market, their long-term potential as well as their volatility can be substantial. Value investing involves the risk that the market may not recognize that securities are undervalued, and they may not appreciate as anticipated. Smaller companies tend to be more volatile and less liquid than larger companies. Small cap companies may also have more limited product lines, markets, or financial resources and typically experience a higher risk of failure than large cap companies.
Fixed-Income Investing Risks
The value of investments in fixed-income securities will change as interest rates fluctuate and in response to market movements. Generally, when interest rates rise, the prices of debt securities fall, and when interest rates fall, prices generally rise. High yield securities, sometimes called junk bonds, carry increased risks of price volatility, illiquidity, and the possibility of default in the timely payment of interest and principal. Bonds may also be subject to other types of risk, such as call, credit, liquidity, and general market risks. Longer-term debt securities are usually more sensitive to interest-rate changes; the longer the maturity of a security, the greater the effect a change in interest rates is likely to have on its price.
The credit quality of fixed-income securities in a portfolio is assigned by a nationally recognized statistical rating organization (NRSRO), such as Standard & Poor’s, Moody’s, or Fitch, as an indication of an issuer’s creditworthiness. Ratings range from ‘AAA’ (highest) to ‘D’ (lowest). Bonds rated ‘BBB’ or above are considered investment grade. Credit ratings ‘BB’ and below are lower-rated securities (junk bonds). High-yielding, non-investment-grade bonds (junk bonds) involve higher risks than investment-grade bonds. Adverse conditions may affect the issuer’s ability to pay interest and principal on these securities.
This material may contain assumptions that are “forward-looking statements,” which are based on certain assumptions of future events. Actual events are difficult to predict and may differ from those assumed. There can be no assurance that forward-looking statements will materialize or that actual returns or results will not be materially different from those described here.
The views and opinions expressed are as of the date of publication, and do not necessarily represent the views of the firm as a whole. Any such views are subject to change at any time based upon market or other conditions and Lord Abbett disclaims any responsibility to update such views. Lord Abbett cannot be responsible for any direct or incidental loss incurred by applying any of the information offered.
This material is provided for general and educational purposes only. It is not intended as an offer or solicitation for the purchase or sale of any financial instrument, or any Lord Abbett product or strategy. References to specific asset classes and financial markets are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations or investment advice.
Certain information contained herein has been obtained from third party sources and such information has not been independently verified by Lord Abbett. No representation, warranty, or undertaking, expressed or implied, is given to the accuracy or completeness of such information by Lord Abbett or any other person. While such sources are believed to be reliable, Lord Abbett does not assume any responsibility for the accuracy or completeness of such information. Lord Abbett does not undertake any obligation to update the information contained herein as of any future date.
Please consult your investment professional for additional information concerning your specific situation.
Glossary & Index Definitions
Dodd–Frank Wall Street Reform and Consumer Protection Act, commonly known as Dodd-Frank, is a United States Federal Law that was enacted on July 10, 2010. The law includes consumer protection reforms, the Volcker rule that prohibits banks from engaging in proprietary trading or investing in hedge funds or private equity funds, enforcement authority for banks and credit unions with assets over $10 billion and all mortgage-related businesses, systemic risk regulations, and derivative regulations.
Basel III is a set of measures developed by the Basel Committee for Banking Supervision in the years following the global financial crisis of 2007-09. The measures, rolled out over several years, aim to strengthen the regulation, supervision, and risk management of banks.
The Securities and Exchange Commission (SEC) oversees securities exchanges, securities brokers and dealers, investment advisors, and mutual funds in an effort to promote fair dealing, the disclosure of important market information, and to prevent fraud.
SEC Rule 22e-4 requires an open-end fund and an exchange-traded fund that redeems in kind (“In-Kind ETF”) to establish a written liquidity risk management program that is reasonably designed to assess and manage the fund's or In-Kind ETF's liquidity risk.
Exchange-traded fund (ETF) is a type of investment fund that is also an exchange-traded product, i.e., it is traded on stock exchanges. ETFs own financial assets such as stocks, bonds, currencies, debts, futures contracts, and/or commodities such as gold.
Internal rate of return (IRR) is the yield-to-maturity of a bond associated with buying that bond and holding it until its maturity date. In other words, it is the return on investment associated with buying the bond and reinvesting its coupon payments at a constant interest rate.
The U.S. Federal Reserve (Fed) is the central bank of the United States. The federal funds (fed funds) rate is the target interest rate set by the Fed at which commercial banks borrow and lend their excess reserves to each other overnight.
Spread is the percentage difference in current yields of various classes of fixed-income securities versus Treasury bonds or another benchmark bond measure. A bond spread is often expressed as a difference in percentage points or basis points (which equal one-one hundredth of a percentage point). The option-adjusted spread (OAS) is the measurement of the spread of a fixed-income security rate and the risk-free rate of return, which is adjusted to take into account an embedded option. Typically, an analyst uses the Treasury securities yield for the risk-free rate.
A basis point is one one-hundredth of a percentage point.
Yield is the income returned on an investment, such as the interest received from holding a security. The yield is usually expressed as an annual percentage rate based on the investment's cost, current market value, or face value. Yield-to-worst refers to the lesser of a bond’s (a) yield-to-maturity or (b) the lowest yield-to-call calculated on each scheduled call date.
Bloomberg Index Information
Source: Bloomberg Index Services Limited. BLOOMBERG® is a trademark and service mark of Bloomberg Finance L.P. and its affiliates (collectively “Bloomberg”). Bloomberg owns all proprietary rights in the Bloomberg Indices. Bloomberg does not approve or endorse this material or guarantee the accuracy or completeness of any information herein, or make any warranty, express or implied, as to the results to be obtained therefrom and, to the maximum extent allowed by law, shall not have any liability or responsibility for injury or damages arising in connection therewith.
Source ICE Data Indices, LLC (“ICE”), used with permission. ICE PERMITS USE OF THE ICE BofAML INDICES AND RELATED DATA ON AN “AS IS” BASIS, MAKES NO WARRANTIES REGARDING SAME, DOES NOT GUARANTEE THE SUITABILITY, QUALITY, ACCURACY, TIMELINESS, AND/OR COMPLETENESS OF THE ICE BofAML INDICES OR ANY DATA INCLUDED IN, RELATED TO, OR DERIVED THEREFROM, ASSUMES NO LIABILITY IN CONNECTION WITH THE USE OF THE FOREGOING, AND DOES NOT SPONSOR, ENDORSE, OR RECOMMEND LORD ABBETT, OR ANY OF ITS PRODUCTS OR SERVICES.
Indexes are unmanaged, do not reflect the deduction of fees or expenses, and are not available for direct investment.
This material is the copyright © 2024 of Lord, Abbett & Co. LLC. All Rights Reserved.
Important Information for U.S. Investors
Lord Abbett mutual funds are distributed by Lord Abbett Distributor LLC.
FOR MORE INFORMATION ON ANY LORD ABBETT FUNDS, CONTACT YOUR INVESTMENT PROFESSIONAL OR LORD ABBETT DISTRIBUTOR LLC AT 888-522-2388, OR VISIT US AT LORDABBETT.COM FOR A PROSPECTUS, WHICH CONTAINS IMPORTANT INFORMATION ABOUT A FUND'S INVESTMENT GOALS, SALES CHARGES, EXPENSES AND RISKS THAT AN INVESTOR SHOULD CONSIDER AND READ CAREFULLY BEFORE INVESTING.
The information provided is not directed at any investor or category of investors and is provided solely as general information about Lord Abbett’s products and services and to otherwise provide general investment education. None of the information provided should be regarded as a suggestion to engage in or refrain from any investment-related course of action as neither Lord Abbett nor its affiliates are undertaking to provide impartial investment advice, act as an impartial adviser, or give advice in a fiduciary capacity. If you are an individual retirement investor, contact your financial advisor or other fiduciary about whether any given investment idea, strategy, product, or service may be appropriate for your circumstances.
Important Information for non-U.S. Investors
Note to Switzerland Investors: In Switzerland, the Representative is ACOLIN Fund Services AG, Leutschenbachstrasse 50, CH-8050 Zurich, whilst the Paying Agent is Bank Vontobel Ltd., Gotthardstrasse 43, CH- 8022 Zurich. The prospectus, the key information documents or the key investor information documents, the instrument of incorporation, as well as the annual and semi-annual reports may be obtained free of charge from the representative. In respect of the units offered in Switzerland, the place of performance is at the registered office of the representative. The place of jurisdiction shall be at the registered office of the representative or at the registered office or domicile of the investor.
Note to European Investors: This communication is issued in the United Kingdom and distributed throughout the European Union by Lord Abbett (Ireland) Limited, UK Branch and throughout the United Kingdom by Lord Abbett (UK) Ltd. Both Lord Abbett (Ireland) Limited, UK Branch and Lord Abbett (UK) Ltd are authorized and regulated by the Financial Conduct Authority.
Lord Abbett (Middle East) Limited is authorised and regulated by the Dubai Financial Services Authority (“DFSA”). The entire content of this document is subject to copyright with all rights reserved. This research and the information contained herein may not be reproduced, distributed or transmitted in any jurisdiction or to any other person or incorporated in any way into another document or other material without our prior written consent. This document is directed at Professional Clients and not Retail Clients. Any other persons in receipt of this document must not rely upon or otherwise act upon it. This document is provided for informational purposes only. Nothing in this document should be construed as a solicitation or offer, or recommendation, to acquire or dispose of any investment or to engage in any other transaction. Nothing contained in this document constitutes an investment, an offer to invest, legal, tax or other advice or guidance and should be disregarded when considering or making investment decisions.
Investors should carefully consider the investment objectives, risks, charges and expenses of the Lord Abbett Funds. This and other important information is contained in the fund's summary prospectus and/or prospectus. Click here to obtain a prospectus or summary prospectus on any Lord Abbett mutual fund or contact your investment professional or Lord Abbett Distributor LLC at 888-522-2388. Read the prospectus carefully before you invest or send money.
Not FDIC-Insured. May lose value. Not guaranteed by any bank. Lord Abbett mutual funds are distributed by Lord Abbett Distributor LLC. For U.S. residents only.
The information provided is not directed at any investor or category of investors and is provided solely as general information about Lord Abbett’s products and services and to otherwise provide general investment education. None of the information provided should be regarded as a suggestion to engage in or refrain from any investment-related course of action as neither Lord Abbett nor its affiliates are undertaking to provide impartial investment advice, act as an impartial adviser, or give advice in a fiduciary capacity. If you are an individual retirement investor, contact your financial advisor or other fiduciary about whether any given investment idea, strategy, product or service may be appropriate for your circumstances.
Copyright © 2025 by Lord, Abbett & Co. LLC. All rights reserved.
Lord Abbett communicates with clients solely via e-mail¸ mobile application and/or website on our official domain, lordabbett.com. Communications received via any other channel have not been authorized by Lord Abbett.