Bond navigators: Secured by experience – the origins of our credit

Credit is a cornerstone asset class for many investors. Credit investing is sometimes portrayed as a homogenous activity, but we disagree: the nature of credit markets makes a homogenous approach less appropriate, not more.

In the first of a three-part series, we examine the nature of credit markets and how Royal London Asset Management developed a long-term award-winning approach that has delivered for clients over many years.

For over three decades, our credit team has been building and managing corporate bond portfolios for clients. During that time, credit markets have transformed. They have become larger, more global, more benchmark-driven and more heavily influenced by regulation and technology. Yet the core foundations of our approach have remained strikingly consistent.

That continuity matters. Several of the key architects of the approach remain involved in shaping portfolios today, while also helping the next generation of portfolio managers and analysts develop the same fundamental understanding of credit. The philosophy and process have evolved, but our origin story still informs how we think about risk, structure the team and, ultimately, deliver more robust and effective credit portfolios.

Where it started

Our credit philosophy can be traced back to a simple but powerful idea: the market does not always price credit fundamentals correctly. Our early portfolios expressed this most clearly through allocations to secured but unrated bonds. As our origin predated the dominance of credit rating agencies and bond indices, we were only prepared to lend our clients’ money to riskier corporates if we had a direct claim over that company’s assets.

The market does not always price credit fundamentals correctly.

Over time, as the industry’s delegation to credit ratings ramped up, these attractive assets became increasingly overlooked, to the extent that despite their stronger fundamentals they often yielded more than their unsecured but rated counterparts. For us, as active managers, such an overt subversion of economic theory – lower risk, higher return – was a gift which we were not prepared to waste.

This was not an outright rejection of ratings or market convention, but a refusal to outsource wholesale credit judgement to them; not least because ratings tend to consider only half the credit risk – probability of default rather than loss given default. As owners of bonds in the real world, we felt our evaluation must be more comprehensive than this.

With markets developing around unsecured bond archetypes, this presented an opportunity to extend our preference for unrated bonds into wider secured credit markets, where perceived complexity, alongside blunt rating methodologies, was driving further dislocations. What began with a focus on unrated bonds evolved into building credit funds with three to four times the allocation to secured bonds compared to typical bond benchmarks while still offering clients material excess yield. This is an important structural advantage that persists across our credit funds today.

The fundamental credit truths have not changed

While the world around us has transformed in unimaginable ways, the fundamental truths of credit and what it means to be a creditor have not. Credit risk and return remain asymmetric. The upside is generally limited to the receipt of interest and repayment of principal; the downside can be total loss. Factor in a world where uncertainty is the only certainty, and it makes for a difficult credit equation. Against this backdrop, we have always felt duty bound to rebalance this skew where we can.

Understanding the asymmetry of credit risk not only underpins the relative attractiveness of secured lending, but it also frames everything we do as a credit team. This begins with our research framework and its primary aim of evaluating the stability of borrowers’ balance sheets, durability of cash flows, strength of legal claims and quality of protections available if a borrower weakens. Ultimately, our analysis and relative value assessments are focused on one thing: ensuring conviction that our opening lending position will not deteriorate. It may not seem as glamorous or open-ended as equity analysis, but it is the critical essence of good credit analysis.

Ultimately, our analysis and relative value assessments are focused on one thing: ensuring conviction that our opening lending position will not deteriorate.

Furthermore, these bottom-up convictions must be combined with effective construction of a diversified portfolio, helping to dampen heightened specific risk. Inevitably, credit losses cannot always be avoided, but their portfolio impact can be managed by ensuring that no single event dominates the overall outcome. Ego and misplaced conviction have never been welcome bedfellows in a credit context.

Although we were always confident in the intuition behind these concepts, our conviction – and the team’s collective experience – has been forged by repeated real-world testing. The dot-com downturn, the Global Financial Crisis, the sovereign crisis, Brexit, Covid and multiple episodes of banking and geopolitical stress all exposed the difference between relying on more cosmetic bond characteristics and truly valuable credit enhancements, fundamental credit analysis and portfolio diversification.

Accelerating commoditisation

From an early stage, we observed that many investors placed excessive weight on convenient but ultimately more superficial characteristics. While ratings, issue size, benchmark eligibility and familiar names can all be helpful reference points and inputs to credit decisions, none are a substitute for a true understanding of credit fundamentals.

These behaviours have, if anything, become more entrenched as credit markets have grown. They have moved from being an investment backwater to become the critical engine room for cash flow and liability matching, and if you are trying to meet a defined solution in a spreadsheet, standardisation is seductive. Consequently, familiarity is prized, while idiosyncrasy and nuance are often distrusted. In a market dominated by unsecured corporate bonds with point-in-time credit ratings that permit entry into a bond index – and onto the buying lists of ETFs, fixed maturity propositions and annuity funds – less conventional bond issuers and bond types are considered an oddity. This has further accelerated the next period of corporate bond commoditisation.

Familiarity is prized, while idiosyncrasy and nuance are often distrusted.

The net result is that more superficial characteristics remain coveted, while truly supportive fundamentals can be overlooked. For active investors, with the motivation and ability to identify such mispricing, there is a clear opportunity to build credit funds off more stable foundations, elevating both the resilience and level of potential returns.

The same logic applies to artificial segmentation within credit markets. Corporate bonds, secured credit and asset-backed securities (ABS) are often treated as separate silos, but the underlying investment question is the same: does the bond offer attractive compensation for the risks being taken? In our experience, a portfolio that combines secured and unsecured corporate bonds and carefully selected securitisations exhibits demonstrably stronger credentials than a purely unsecured credit fund.

Identifying and exploiting the opportunity

Identifying and capturing these opportunities requires experience in analysing bond specifics and evaluating fundamentals, and a team structure that encourages dynamic interaction. Our team has grown over time, but the objective has remained consistent: to be large enough to bring diversity of expertise and challenge, while remaining lean enough to avoid bureaucracy, inflexibility and diluted decision-making. A collaborative team structure helps ensure that research is not detached from implementation, and that decision-making benefits from experience without becoming fragmented.

For a team that needs to maintain the most efficient size and structure, majoring on tangible credit enhancements and structural drivers of balance sheet stability has always felt like an effective allocation of our research resources. By contrast, relying on trying to find conviction in more subjective assessments has always felt less compelling, especially if it ends up with larger team size as compensation for lower clarity.

As our reach has expanded, across short- and long-dated credit, secured and unsecured bonds, structured credit, ABS, sustainable credit and wider global opportunities, the core discipline has remained the same. And to this end, the asymmetry of bond risk, so clearly a challenge to be mitigated, becomes an advantage – we don’t have to own every bond as the opportunity cost of non-ownership is low. We can therefore remain singularly focused on finding the bonds we want to own – the bonds that will incrementally improve the risk-adjusted return of the overall portfolio.

We don’t have to own every bond as the opportunity cost of non-ownership is low.

More recently, technology and the controlled adoption of agentic AI tools are allowing us to successfully scale our bottom-up, analytical approach while preserving our core competencies. This has opened up access to more global issuers, assessed through exactly the same credit lens. But technology does not remove the need for judgement. Most notably, investors’ over-reliance on machine outputs and common datasets will perpetuate the very dynamics that we have been navigating and exploiting for many years.

A seasoned philosophy for a modern market

Evidently, the asset class has expanded, credit markets have evolved and the industry has changed. Similarly, our credit team has also expanded and our offering has evolved, but at its core our approach has not changed. Underpinning this is a distinctive origin story that has endured, providing coherence and clarity during periods of remarkable volatility and uncertainty. Thirty years on, we believe that the foundations it established, in a credit market that has commoditised its lending and investing decision-making, could not be any more contemporary.

For professional investors only. This material is not suitable for a retail audience. Capital at risk. This is a financial promotion and is not investment advice. Past performance is not a guide to future performance. Reference to any security is for information purposes only and should not be considered a recommendation to buy or sell. The views expressed are those of the author at the date of publication unless otherwise indicated, which are subject to change.