Credit Investments

Besides investing in equity, which means being an "owner" of the company, investors may also lend money to the company by buying a corporate bond. In credit investment, sometimes referred to as "debt investing", an investor lends money to the borrower, and benefits from earning interest on the loan over time.

As bonds are tradable, an investor may also gain profit by selling the corporate bond at a higher price, if the bond's yield to maturity declines over the holding period. In general, credit investments are considered to come at a lower risk than equity investments, but also come at a lower return. However, significant loss can occur in the case of default, where the investor can lose a large portion if not the whole investment.

Government bonds, also known as sovereign debt, are debt securities issued by governments and are considered to be the safest category from the credit (default) risk point of view. While we have seen some sovereign debt defaults over history (Argentina in 2001 and several times since then, Russia in 1998, etc.), government bonds issued by developed country governments are typically very safe.

In the United States, government bonds are issued by the US Treasury and are typically categorized as:

The yield-to-maturity (YTM) of these bonds represents the internal rate of return (IRR) that makes the present value of the cash flows equal to the market price. Short-term interest rates are determined by central banks' monetary policy (Federal Reserve in the US), while long-term rates fluctuate based on policy expectations, inflation outlook, and term premiums.

Corporate bonds have a higher risk of default than government bonds, so investors require a higher yield and higher return from them. The extra yield on a corporate bond compared to a similar maturity government bond is called the credit spread. This spread compensates bond investors for taking higher credit risk.

There are two broad categories of corporate bonds from the credit risk perspective:

Corporate bonds are usually rated by one or more of the three primary ratings agencies: Moody's, Standard & Poor's, and Fitch. These ratings range from AAA down to D, providing investors with standardized risk assessments.

Due to the volatile nature and higher default probability of non-investment grade corporate bonds, they offer higher returns as compensation for increased risk. Credit spreads fluctuate based on economic conditions, market sentiment, and company-specific factors.

Structured credit investments typically refer to securitized bonds—bonds backed or "collateralized" by a pool of many individual loans such as mortgage loans, credit card loans, or auto loans. These investments encompass three main categories:

The non-public segment of credit investing has experienced significant growth following the 2008 financial crisis. Increased bank regulations and capital requirements caused traditional lenders to retreat from small and middle-market company lending, creating opportunities for direct lending or private credit.

Credit investments provide essential diversification benefits and income generation opportunities within a well-balanced portfolio. Understanding the risk-return characteristics of different credit categories—from safe government bonds to higher-yielding private credit—enables investors to construct portfolios that match their risk tolerance and return objectives while providing steady income streams.