Tight spreads don't tell the whole story. The most compelling opportunities in US credit right now may be hiding in plain sight.
Anne Greenwood, Institutional Portfolio Manager on RBC GAM's BlueBay U.S. Fixed Income team, breaks down why the U.S. high yield market's quiet quality transformation is creating real opportunity for active managers - just as the AI trade begins to test investor appetite.
The AI tailwind in corporate bonds may be waning, and that changes the question investors need to be asking.
BB-rated bonds now make up roughly half the US high yield index, up from a third pre-2010, while the riskiest borrowing has migrated to leveraged loans and private credit.
High yield spreads at ~270bps look tight versus a 500bps+ historical average, but index-level data masks significant dispersion - and that's exactly where active managers can add value.
Transcripts
Welcome back to The Weekly Fix. In this episode, we're taking a break from the AI trade and turning to some of the less glamorous corners of the fixed income and credit markets.
Unlike equities, the biggest winners in credit are rarely the companies doing the most exciting things. In fact, it's usually the opposite. They're usually the ones becoming less risky — and the ones where uncertainty is decreasing.
The second quarter gave us a few clear examples of this. Take Paramount. Paramount's hybrid debt fell sharply in the first quarter as capital structure and leverage concerns related to the pending Warner Brothers acquisition forced a downgrade to high yield. In the second quarter, the hybrids returned over 19%, in just one quarter. Paramount's hybrids didn't rally because its operating performance materially improved overnight. They rallied because execution and financing risk around the transaction was reduced, and generated a return multiple of more than 8x the high yield index over the quarter as a result.
Now Paramount's situation is not resolved, but the impact of less uncertainty was profound.
This framing matters right now because the AI tailwind investors have been reliant on may be starting to wane with AI-related issuance finally beginning to test investor appetite for corporate bonds.
As a result, investors are starting to ask themselves a different question: who are the borrowers that are becoming less risky, not more. And one — continuously under-appreciated — answer is the US high yield market itself.
the index versus a third pre-:
The catch is, high yield spreads of roughly 270 basis points, compared to a historical average of over 500 basis points, look extremely tight today. But index-level spreads are masking the dispersion of mis-priced uncertainty lying under the hood. And that makes this an exciting time to be an active manager, because by being able to capitalize on this mispriced uncertainty is how we look to add value.
So, while investors remain hyper-focused — no pun intended — on the AI story, they may be overlooking a number of issuers and sectors quietly becoming the unsung heroes of US credit markets generating meaningful returns in portfolios.
