Managing Credit Risk in Fixed-Income Portfolios

Very Hard Risk Management Credit Risk Management

During a recent investment committee meeting, the portfolio management team at Apex Wealth Management discussed the rising credit risk posed by various industries amid economic uncertainty. The team noted that historical data show most defaults occur in recessionary periods, particularly in certain sectors. To mitigate exposure to these risks, they considered diversifying their fixed-income holdings and implementing a credit overlay strategy. This strategy involves active management of the credit exposure within the portfolio by adjusting allocations dynamically based on credit ratings, duration, and current market conditions.

Apex's allocation includes investment-grade corporate bonds, high-yield corporate bonds, and emerging market debt. The chief risk officer emphasized the importance of monitoring credit spreads as a leading indicator of credit risk, which can provide valuable insights into potential defaults.

Given this context, which of the following strategies would most effectively manage the overall credit risk of Apex’s portfolio?

Increasing exposure to sectors historically stable during economic downturns, even if they have lower yields.

Rebalancing the portfolio to include more high-yield bonds as credit spreads widen.

Using credit default swaps (CDS) to hedge against specific credit exposures in the portfolio.

Hint

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