Credits

Credits are, in essence, loans made by an investor to a borrower, which could be a corporation, a national government, or even a local municipality. When you invest in a credit instrument, you are lending your money in exchange for a promise. This promise typically involves two key components: the borrower agrees to make regular interest rate payments (often called 'coupon' payments) to you over a set period, and then to return your original investment, the principal, on a specific future date known as the maturity date. This makes credits a form of debt financing for the issuer and a type of fixed-income investment for the lender. The world of credits is vast, ranging from ultra-safe government IOUs to riskier corporate promises. For investors, they offer a different risk-and-return profile compared to stocks (equity), generally providing more predictable, albeit often lower, returns.

Why do credits even exist? Think of them as a fundamental gear in the engine of capitalism, serving two distinct but complementary purposes for borrowers and lenders.

Imagine a company wants to build a new factory or a government needs to fund a new motorway. They need cash. One option is to sell ownership stakes (stocks), but this dilutes the control of existing owners. A powerful alternative is to borrow the money by issuing credits (often in the form of bonds). This allows them to raise huge amounts of capital for growth and projects without giving up any ownership. They simply promise to pay the money back with interest. It's the financial equivalent of taking out a mortgage on a new project.

For an investor, buying a credit is like becoming a lender. The primary appeal is predictable income. Unlike the fluctuating dividends from stocks, the interest payments on most credits are fixed and regular. You know exactly how much you'll receive and when. Furthermore, credit holders have a higher claim on a company's assets than stockholders. If the company goes bankrupt, the lenders (credit holders) are first in line to get paid back from any remaining assets, making credits generally safer than stocks from the same issuer.

The term 'credits' is a broad umbrella covering a variety of debt instruments. They are typically categorized by who is doing the borrowing.

Often considered the bedrock of the fixed-income world, these are debts issued by national governments.

• In the United States, these are known as Treasuries (e.g., Treasury bonds, notes, and bills), and are backed by the 'full faith and credit' of the U.S. government, making them a global benchmark for safety.
• In the United Kingdom, they are called gilts.
• In Germany, they are known as Bunds.

Because the risk of a major government defaulting on its own currency debt is extremely low, these credits typically offer lower interest rates.

When companies like Apple or Ford need to borrow money, they issue corporate credits, most commonly as corporate bonds. This is where things get more interesting for a value investor. Unlike a government, a company can go out of business. Therefore, lending to a company involves credit risk—the risk that the borrower will fail to make its payments. To help investors gauge this risk, specialized firms called credit rating agencies, such as Moody's and S&P Global Ratings, analyze a company's financial health and assign it a rating.

1. Investment-grade bonds: These are issued by financially stable companies and are considered relatively safe.
2. High-yield bonds (informally known as 'junk bonds'): These are issued by companies with weaker financial health. To compensate investors for the higher risk of default, they offer much higher interest rates.

The universe of credits also includes:

• Municipal bonds ('Munis'): Issued by states, cities, or other local authorities to fund public projects like schools and bridges. In the U.S., their interest income is often exempt from federal taxes.
• Asset-backed securities (ABS): These are credits created by pooling together various types of loans (like car loans or credit card debt) and selling slices of that pool to investors. A famous (or infamous) example is the mortgage-backed security (MBS).

For a value investor, credits aren't just a 'safe' alternative to stocks; they are an investment class to be analyzed with the same rigor. The philosophy of value investing, championed by figures like Benjamin Graham and Warren Buffett, applies just as much to debt as it does to equity.

A value investor doesn't blindly trust a credit rating. They do their own homework. They'll pour over a company's financial statements—the balance sheet, income statement, and cash flow statement—to answer one crucial question: Can this company comfortably afford its interest payments and repay the principal when it's due? They look for companies with strong, durable earnings and manageable debt loads. This deep-dive analysis is the core of assessing the true risk, not the one perceived by the market.

The ultimate goal is to find mispricings. Sometimes, the market overreacts to bad news, punishing a company's bonds and pushing their price down (which pushes their yield, or effective interest rate, up). A value investor who has done their homework might recognize that the company's long-term ability to pay its debts is still intact. By buying these temporarily out-of-favor credits, they can lock in a high, predictable return for a level of risk that is much lower than the market believes. It's about buying a dollar's worth of a solid promise for eighty cents.