Credit-Improvement Selection
Buy improving credits before rating agencies recognize the change
- Difficulty
- Expert
- Time to result
- ~months to results
- Steps
- 6
- Confidence
- 93%
Credit-Improvement Selection looks beyond an issuer's current rating to the path its management can follow toward stronger credit quality. The analyst maps maturities, liquidity, refinancing access, leverage, and operating cash flow, then identifies specific actions that could place the company on firmer footing. Because rating agencies may recognize improvement only after it becomes visible in reported results, disciplined fundamental research can identify an upgrade trajectory earlier. The framework is particularly useful when broad spreads are tight and asset-class switching offers limited advantage, making issuer-specific change the primary return driver. It does not mean indiscriminately buying low-rated debt: the improvement path must remain credible under adverse scenarios, and the security's spread must compensate for execution risk.
Origin
Extracted from Masters in Business, where Ed Perks explains Franklin's emphasis on higher-quality high yield and issuers improving ahead of rating agencies.
Core principles
- 01Favor an improving credit path over a static rating label
- 02Treat refinancing and maturity management as core evidence
- 03Use fundamental analysis to anticipate rating changes
- 04Demand issuer-level work when broad spreads offer little compensation
- 05Prefer higher-quality high yield when sector spreads are tight
How to run it
- 1
Map the Obligations
Lay out maturities, secured and unsecured claims, interest costs, covenants, and near-term cash requirements.
Pro tip Concentrate first on the periods where refinancing pressure is highest.
- 2
Assess Liquidity and Access
Evaluate cash, free cash flow, revolving facilities, asset-sale options, and access to capital markets.
Watch out Nominal liquidity can disappear quickly if covenants or market access tighten.
- 3
Define Management's Path
Identify the concrete steps management can take to refinance debt, extend maturities, reduce leverage, or improve coverage.
Pro tip Require actions and timelines rather than general statements about deleveraging.
- 4
Stress-Test the Path
Model weaker revenue, margin pressure, higher refinancing costs, and delayed transactions. Determine whether the issuer can still reach a more solid footing.
Watch out A plan that works only under optimistic assumptions is not an improving credit.
- 5
Compare With Ratings and Price
Assess whether current ratings and spreads fully reflect the likely improvement. Look for a gap between fundamental progress and external recognition.
Pro tip Focus on evidence that may precede a rating-agency upgrade.
- 6
Monitor Milestones
Track refinancing, maturity extensions, leverage, coverage, and liquidity against the original thesis. Exit or resize when management misses critical milestones.
Watch out Do not let an anticipated upgrade become an excuse to ignore deterioration.
In the wild
A double-B issuer has adequate cash flow but a concentrated maturity wall. Management refinances near-term debt, extends maturities, and directs excess cash toward leverage reduction before the rating agencies formally change their assessment.
→ The investor benefits as perceived credit risk and spreads decline ahead of a later upgrade.
A B-minus company offers a high yield, but its improvement plan requires uninterrupted market access and optimistic earnings growth. Stress testing shows that a modest downturn would exhaust liquidity before refinancing.
→ The investor avoids treating all securities within the same rating bucket as equivalent opportunities.
Common mistakes
Treating Ratings as Real-Time Analysis
Ratings can lag changes in issuer fundamentals and should not replace independent assessment.
Ignoring the Maturity Wall
A company with acceptable current earnings can still fail if debt comes due before liquidity or refinancing is secured.
Buying Yield Without a Credible Path
A large spread is not sufficient when management lacks concrete, stress-resistant steps toward stronger credit quality.
Is it for you?
Best for
Fundamental credit investors researching individual high-yield issuers with refinancing or balance-sheet improvement potential.
Not ideal for
Passive investors unable to perform issuer-level analysis or tolerate the downside of failed improvement plans.
From the transcript
“What is an individual company doing to be able to refance the debt to turn out their maturities, or ultimately to improve the overall credit…”
“We do think grating agencies lag by a significant margin”
“really understanding that that path that management has to ensure that the company moves to a more solid footing”
From the episode
Franklin Templeton's Ed Perks on Fixed Income Investing
Ed Perks