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Introduction

Investment grade xed income has always been a key component in well diversied

investment portolios. Over the last several years, the asset class has gained even

more traction, as the increased volatility witnessed during the global nancial crisis

has driven investors to seek more stable portolio returns. In addition to oering

attractive valuations versus government bonds, investment grade credit represents on

o the largest and highest quality investment opportunity sets and has, consequently,

been a beneciary o increased investor appetite.

The need or investors to diversiy their credit exposures has generated interest in

global investment grade credit solutions. However, this has introduced a number o

complexities and unintended risks into portolios, such as exposure to oreign exchang

rates and sensitivity to global interest rate curves. I not managed or hedged properly

these risks could negate the perceived diversication benets o adding global

investment grade credit. As an alternative, we believe that it is possible, and even

preerable or investors to capture global credit exposure in US dollar-denominated

global credits through an actively managed investment grade strategy. While some

investors actively seek exposure to a wide variety o currencies and international

yield curves in their xed income allocations, we believe that the volatility and risks

associated with such an approach will likely dampen the value o a higher quality and

stable target return or an investment grade allocation.

The Opportunity Set and Alpha Generation in Global

Investment Grade Credit

Proponents o global investment grade credit list, among their reasons or

considering the asset class, its breadth o opportunities versus what is available

in individual country credit allocations. Their argument is that there should be

a resulting increase in alpha and inormation ratios, given the broader credit

universe, currencies and interest rate curves. Grinolds undamental law o active

management stipulates that inormation ratio (IR) is equal to inormation coecient

(IC) multiplied by the square root o breadth (N).

IR=IC*SQRT(N)

Looking at this ormula, it is clear why one would expect the IR or global investmentgrade managers, on average, to be higher than or US investment grade managers, a

the opportunity set, or breadth, is larger. Further, in theory, the orecasting ability o

the manager, measured by IC, should not dier much whether a manager is running

global or a country specic portolio.

To test this hypothesis, we analyzed the IRs o all managers in the eVestment Alliance

Global and US Investment Grade Universes. Contrary to the hypothesis, the data

shows that, on average, the inormation ratio or the US credit universe was higher

than that o the global universe or the 3- and 5-year periods shown in Figure 1.

Look No Further: Global Credit Exposure

Through Actively Managed USD-Denominated

Investment Grade Credit

Dr. Vladimir Karlov

Managing Director, Chairman, PineBridge

Investment Solutions Committee

PineBridge Investments, New York

Robert Vanden Assem, CFA

Managing Director, Head of US Investment

Grade Fixed Income

PineBridge Investments, New York

This material must be read in conjunction with the disclosure statement.

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As can be seen, while the Global and US Credit universes

are dierent in the number o issues, the gap between

the liquid USD universe and the global liquid universe

is minimized in notional terms. In addition, as refected

in Figure 3, the most liquid international names tend to

issue bonds in the USD market. Thus, by ocusing on the

liquid subsets o the universes, the breadth appears to be

quite similar.

Another measure that can be used to estimate the

dierence in breadth o the two universes is the dispersion

o spreads. Shown in Figure 4, this measurement is a good

proxy or alpha generation capacity rom credit selection

and we see that the numbers or the two universes are

airly similar. In act, Europe, Japan and the Rest o the

World have more spread and alpha potential in the USD

liquid universe than in the global universe. Hence, the

ewer issues in the USD universe versus the Rest o

the World shouldnt present a problem rom an alpha

generation perspective.

Given the similar breadth in liquid credit opportunities

between two universes, we can see why the global

universe does not actually achieve the hypothesized

increase in IR. Nevertheless, this does not explain why

the IR or global managers is actually lower. This is likely

explained by the act that the only additional opportunity

sets available to global managers are currency and

duration. As managers take uncompensated currency and

duration bets, they detract rom their credit decisions.

Thereore, on a risk-adjusted basis, it is generally a lot

more dicult to consistently make successul currency

and duration bets. Since most US credit managers take

very little o these risks, they are in a better position to be

rewarded or their decisions.

Non-US investors who preer a credit strategy that is

denominated in a currency other than the US dollar can

easily tailor the strategy to t their needs. This can be

achieved by bringing the USD credit component to the right

Not only did the average US manager perorm better, but

so too did the universe as a whole. This analysis shows

that expanding the opportunity set may actually detract

rom alpha generation and that the IC decreases between

two and our times aster than the square root o the

breadth. Clearly, there must be an explanation or thisphenomenon. To try to unlock the mystery, we rst look

to see i the opportunity sets o the two universes are

really that much dierent. Figure 2 shows the geographic

breakdown (by number o issues, market value and

currency exposure) o the Barclays Capital Global Credit

and US Credit indices and the Liquid USD Universe.

FIGURE 1Universe Characteristics:Active Global vs. Active US

US Credit3 Year

GlobalCredit3 Year

US Credit5 Year

GlobalCredit5 Year

High 2.85 2.56 1.35 0.86

5th Percentile 2.35 1.48 1.22 0.75

25th Percentile 1.79 1.03 0.73 0.36

Median 1.00 0.58 0.39 0.1075th Percentile 0.21 0.18 -0.16 -0.12

95th Percentile -0.80 -0.44 -0.36 -0.73

Low -1.67 -1.25 -0.45 -0.79

Source: eVestment Alliance

FIGURE 2Universe Characteristics: Global and USIncluding Liquid Subsets

GlobalCredit

GlobalCredit

USCredit

LiquidUSD

Credit

LiquidGlobalCredit

Issues

Notional %

Currency

Exposure

Issues

Notional %

Issues

Notional %

Issues

Notional %

US 3,653

34.8%

60.5% 3,815

67.9%

1,454

57.7%

1,643

35.6%

Europe 1,949

28.3%

24.1% 230

14.3%

173

12.4%

1,154

32.3%

Japan 731

8.0%

3.6% 94

4.8%

66

3.7%

432

9.0%

UK 229

2.5%

6.6% 42

1.8%

35

1.6%

78

1.8%

Australia 415

4.2%

1.3% 30

1.4%

28

1.3%

40

0.9%

Rest oWorld

1,597

22.0%

3.9% 575

27.3%

393

23.3%

522

20.4%

Source: Barclays Capital. Data as o March 31, 2012. The liquid universes aresegmented out o the broader credit indices by average bid-ask spread as oreerence quarter-end.

FIGURE 3Liquid Issuers in the Global and USDCredit Markets

LiquidGlobal Issuers

LiquidUSD Credit

US 58.01% 54.93%

Europe 64.60% 86.38%

Japan 63.40% 77.40%

UK 39.98% 87.94%

Australia 12.46% 92.07%

Rest o World 52.68% 85.53%Source: Barclays Capital. Data as o March 30, 2012. The liquid universes aresegmented out o the broader credit indices by average bid-ask spread as oreerence quarter-end.

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duration on the curve in the investors currency o choice.

For example, Australian investors could (1) hold USD-

denominated investment grade credit, (2) execute swaps

that change the duration o the portolio rom xed to

foating, and (3) hedge USD into Australian Dollars (AUD).

This would have resulted in a spread o approximately

170 bps over AUD cash as o the end o April 2012. The

investor could then either move the spread to their desired

position on the curve or simply keep the 170 bps in credit

without taking any interest rate risk. Such exposure to

USD-sourced global investment grade credit presentsan attractive, active opportunity rom a risk-return

perspective and could result in high marginal return on

economic capital.

Why Investment Grade Credit in theCurrent Macroeconomic Environment

In addition to the benets o using US dollar denominated

investment grade credit instead o global credit as described

above, the US credit market also has a bright outlook in

the current macroeconomic environment. The option-

adjusted spread (OAS) o the Barclays Capital U.S. Credit

Index was trading at more than 170 basis points at the end

o April 2012, a level that indicated that the investment

grade market was already partially pricing in the chance

o a double dip recession. We believe that this makes the

asset class attractive rom both a undamental and valuation

perspective.

As governments in the developed world have sought

to spend their way back to economic growth, private

companies have ocused on improving their liquidity proles

and cost structures. The ocus on balance sheet discipline

has been bolstered by the low rate environment that has

pushed investors to the relative attractiveness o corporate

debt and driven strong demand or the asset class. A

signicant increase in cash balances has been generated,

given the ability o companies to access the debt markets

and overall reductions in capital expenditures. Corporate

balance sheet discipline has also included a trend toward

lower leverage, as companies seek to maintain strong

credit metrics.

The European sovereign debt crisis belies a more global

trend among developed nations to increase debt. In the

US, debt-to-GDP levels have increased substantially as

the government has sought to stimulate the economy

weakened by the nancial crisis and a prolonged housing

slump. Specically, high debt levels are not only evident

at the ederal level, but also across the nation in states

and municipalities, that are acing rating downgrades

and scal diculties in the oreseeable uture. Going

orward, corporate scal discipline will remain a key ocus,

especially given the uncertain economic environment.

Thereore, a strategy that employs investments in an asset

class that exhibits stable to improving undamentals, with

a ocus on selection at the security level, is one that makes

good sense.

ConclusionIn summary, direct exposure to the global credit universe

introduces oreign exchange and duration exposure in

other currencies that, i not managed or hedged properly,

may negate all o the perceived diversication benets o

a global credit portolio and result in a low inormationratio. Since the opportunity set available to global credit

managers is actually similar in breadth to what is available

to US credit managers, global credit strategies have

experienced deteriorating inormation ratios as currency

and duration bets have detracted value. Thus, investors

who are looking to capture exposure to global investment

grade credit may consider achieving that exposure through

an actively managed strategy that invests in US dollar-

denominated global investment grade credit and then

hedge the dollar exposure back to their home currency.

Finally, the US investment grade credit markets current

avorable outlook is an additional reason to consider theasset class. n

FIGURE 4 Universe Characteristics: Dispersion

USCredit

GlobalCredit

LiquidUSD

Credit

Liquid GlobalCredit

US 174 +/- 6 263 +/- 6 171 +/- 5 188 +/- 4

Europe 158 +/-12 241 +/-15 213 +/- 12 185 +/- 11

Japan 117 +/-3 65 +/-3 159 +/- 5 85 +/- 6

UK 183 +/-10 273 +/-11 175 +/- 10 228 +/- 10

Australia 119 +/-2 185 +/-8 119 +/- 2 155 +/- 8

Rest o World 105 +/-11 194 +/-12 155 +/- 3 94 +/- 12

Source: Barclays Capital. Data as o March 30, 2012. The liquid universesare segmented out o the broader credit indices by average bid-ask spreadas o reerence quarter-end. Note: Spread dispersion is deined as averageoption-adjusted spread (OAS) +/- monthly volatility.

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Dr. Vladimir Karlov,Chairman, PineBridge Investment Solutions Committee

PineBridge Investments, New York

Mr. Karlov joined the rm in 2000 and is responsible or managing preerred equity portolios. As the Chair o the rms

Investment Solutions Committee, he is involved in establishing House Views with regard to investment opportunities and risks.

He is also engaged in asset allocation decisions, asset-liability management, liability driven investments, execution o structuredand derivatives transactions. Previously, Mr. Karlov was responsible or managing capital structure arbitrage and convertible

portolios. Prior to joining the rm, he was a Consultant in the Financial Risk Management Group at PricewaterhouseCoopers LLP

in New York. At PwC, Mr. Karlov worked with banks, investment management companies, mortgage companies and government

agencies on a wide variety o risk management projects. He received a BS and an MS (Honors) in Applied Mathematics and

Cybernetics at Moscow State University in Russia, and a Doctor o Science in Operations Research rom George Washington

University.

Robert Vanden Assem, CFAManaging Director, Head of Investment Grade Fixed Income

PineBridge Investments, New York

Mr. Vanden Assem joined the rms predecessor company in 2001. He is currently the head o the Investment Grade Fixed Incomegroup and responsible or the management o high grade institutional and retail xed income portolios. Previously, Mr. Vanden

Assem worked at Morgan Stanley Dean Witter Advisors as a Portolio Manager or the MSDW Strategist and Variable Strategist

mutual unds, in addition to other institutional and individual xed income assets. He also managed institutional and individual

monies exclusively, at Dean Witter InterCapital, the precursor to MSDW Advisors. He received a BS in Accounting rom Fairleigh

Dickinson University and an MBA in Finance rom New York University. Mr. Vanden Assem is a CFA charterholder.

BIOGRAPHIES

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