Evaluating Credit Strategies for Fixed Income Portfolio

Global Asset Management, a large institutional investor, has been increasingly shifting its fixed income portfolio towards credit strategies in response to changing market conditions. The fixed income team is currently evaluating three credit strategies: (1) overcoming the benchmark by tilting towards high-yield bonds with a higher default probability, (2) investing in investment-grade corporate bonds while conducting rigorous credit analysis to identify securities that are undervalued, and (3) diversifying the portfolio through increased exposure to emerging market debt with lower liquidity. With tighter spreads and higher correlations among credit securities, the team is particularly focused on the risks and potential returns of these strategies.

The fixed income team has prepared a risk assessment report. An analyst posits that while both high-yield and emerging market bonds can offer potentially higher yields, they also present significant default and liquidity risks. Meanwhile, the investment-grade strategy is being weighed for its risk-adjusted return potential. Which strategy should Global Asset Management select for maximizing long-term total returns with a manageable level of risk?