In credit markets, where transaction costs can reach 70-80 basis points for high-yield bonds, a systematic strategy's success hinges equally on its trading efficiency as on its return forecasts. A good model is useless if its alpha is consumed by trading costs.

The credit market appears healthy based on tight average spreads, but this is misleading. A strong top 90% of the market pulls the average down, while the bottom 10% faces severe distress, with loans "dropping like a stone." The weight of prolonged high borrowing costs is creating a clear divide between healthy and struggling companies.

With corporate credit spreads at historically narrow levels, investors are not being compensated for the inherent risk. In Richard Bernstein's career, spreads have only been this tight three previous times, each preceding a major credit crisis or market scare (late 1990s, mid-2000s, 2021-22). This suggests a poor entry point for credit.

Traditional credit rotation strategies based on beta and starting spreads have become ineffective. Analysis now shows a sector's net supply—the volume of new debt issued versus what's maturing—is the most critical factor determining its relative performance, making technicals more important than fundamentals.

Historically, significant capital rotates from money market funds into corporate credit when the yield advantage hits approximately 100 basis points. With Fed rate cuts anticipated, this key threshold is expected to be reached in the second half of the year, potentially unlocking a portion of the $8 trillion in sidelined cash.

With credit curves already steep and the U.S. Treasury curve expected to steepen further, the optimal risk-reward in corporate bonds lies in the 5 to 10-year maturity range. This specific positioning in both U.S. and European markets is key to capturing value from 'carry and roll down' dynamics.

Judging the credit market by its overall index spread is misleading. The significant gap between the tightest and widest spreads (high dispersion) reveals that the market is rewarding quality and punishing uncertainty. This makes individual credit selection far more important than a top-down market view.

With credit spreads already tight, their potential upside is limited while their downside is significant in a recession scare, offering poor convexity. Goldman Sachs advises that a better late-cycle strategy is to move up the risk curve via equities, which offer more upside potential, rather than through credit investments.

The intermediate part of the curve offers the best risk-reward. Investors can capture "roll-down" returns by holding a bond as it shortens in maturity and its spread tightens. This benefit is absent in flat, long-dated curves, which also lack sufficient natural buyers.