In another example, Xcel Energy, the fourth-largest energy company in the United States, with a delivery network in thirteen states, outsources its IT functions to IBM.Why would Xcel Energy duplicate the capabilities of one of the largest information technology companies in the world when they can partner with them, receive their expertise and knowledge, and spend less for the service?

Let me cite one more example. I once worked with two partners who were in the mortgage banking business. In that business there are many players, each with a specialized role. There are closers who close a real estate transaction, lenders who loan the money, mortgage servicers who handle the loan, and mortgage custodians who manage the documents. This case involved mortgage servicers and mortgage custodians.

The servicers handle customer calls, accept and apply payments, and pay escrowed taxes and insurance for the mortgagee. The custodians file and store the documents and then, when they’re needed, ship them to appropriate locations—a cumbersome process considering the thousands of real estate transactions that occur every day.

The rating agencies have been criticized for being too slow to react to changes in the credit quality of an issuer, leading to serially correlated rating patterns and limiting the value of ratings as a risk management tool. As a reaction, Moody’s decided to put its rating process under review, and acquired KMV to be able to provide investors with additional, marketbased assessments of an issuer’s credit quality. The feedback from market participants was surprising. Since investors themselves tend to use spreads and spread volatility as indicators for credit risk, the vast majority does not want Moody’s or the other rating agencies to switch to a more marketbased approach when assessing the credit quality of an issuer. There is really a need for, according to the feedback, more transparency with regard to the rating process. This would allow investors to use rating agency information in their risk management most efficiently.

Globally, the low interest rate environment in the first years of the new millennium has spurred investors’ interest in credit as a way to boost returns. However, one has to be aware that there is a correlation between the level of interest rates, the slope of the yield curve and credit spreads because both the yield curve and credit spreads reflect the state of the economy.

Since they are driven by expectations about the same underlying factor, the relation between the yield curve and credit spreads has an impact on top-down driven asset allocation and duration decisions.

In the past, credit spreads have been closely correlated with interest rates. There is typically a negative correlation between spreads and the level of interest rates. As interest rates increase due to an improving outlook for future economic growth and rising price pressure, credit quality tends to improve because firms have opportunities to strengthen their future earnings and cashflows. Similarly, a flatter money market slope (2 years–6 months) is usually positive for credit spreads because it indicates better economic conditions. In a difficult economic environment, such as at the trough of the recession, the money market curve tends to be very steep and credit usually underperforms treasuries, especially at the long end.