1. Martin Fridson 1. is a global credit strategist at BNP Paribas Asset Management, Inc., in New York, NY. (martin.fridson{at}bnpparibas.com) 2. Camille Mcleod-Salmon 1. is a research analyst at BNP Paribas Asset Management, Inc., in New York, NY. (camille.mcleod-salmon{at}bnpparibas.com) <!-- --> 1. To order reprints of this article, please contact Dewey Palmieri at dpalmieri{at}iijournals.com or 212-224-3675. Tactical asset allocators operate on the assumption that if risk premiums increase, higher-rated bonds will outperform lower-rated bonds, and that if risk premiums decrease, the reverse will happen. Empirical testing shows, however, that about 30% of the time, these expected relationships break down. Drawing on a classic debate among corporate bond market participants, investors might hypothesize that tactical asset allocators can improve their results by classifying bonds according to market-based risk premiums rather than by agency-generated ratings. In the context of tactical asset allocation, however, Fridson and Mcleod-Salmon do not find the market to be a shrewder judge of credit risk than the rating agencies. The solution to the problem of perverse outcomes in credit-oriented tactical asset allocation may be to combine top-down sector selection techniques with bottom-up security selection. TOPICS: [Portfolio theory][1], [fixed-income portfolio management][2], [analysis of individual risk factors/risk premia][3] [1]: https://www.pm-research.com/topic/portfolio-theory [2]: https://www.pm-research.com/topic/fixed-income-portfolio-management [3]: https://www.pm-research.com/topic/analysis-individual-factorsrisk-premia