Views From the Floor -
The Tastiest Spreads: Credit Opportunities Hiding Behind the Averages

Look through headline number of the bond indices and you'll find over 1,000 bonds trading at a spread above 300 basis points.

Lower-quality companies may face a refinancing reckoning soon. We recommend European financials over their US counterparts as they appear to be in better health as we enter the third quarter.
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All of the classic signs of late-cycle euphoria are on display: accelerating inflation, rising interest rates, over-payment for assets, a glut of issuance. So how should high yield investors prepare themselves if the credit cycle ends?


Credit markets have proven resilient despite the much-talked-about turn of the credit cycle, as discussed in some detail . Spreads do however start to look slightly less compelling when quality degradation is taken into account, and on this basis, BBB global investment grade credit indices’ spreads now trade below the median compared to history, around 163 basis points (bps). But this around-average figure hides a substantially juicier picture for active bond pickers. The number of bonds that are offering an option-adjusted spread (OAS) over 300 basis points (bps) is currently around the 75th percentile. As Figure 1 shows, this dispersion means there are over 1,000 bonds to choose from in the investment grade universe that have a credit spread of more than 300 bps.

Figure 1. Credit Index Averages Hide Dispersion: Over 1,000 bonds with OAS above 300 bps

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Source: Bloomberg, ICE BofA as at 31 May 2023. Euro, sterling and US investment grade indices used as references.

That’s just within investment grade. For high yield investors, the average spread appears to be hiding a barbell distribution of higher-yielding bonds. Within this asset class there are a number of very cheap and very expensive bonds. Some of these bonds remain cheap for a reason and we would expect to see more stress and distress within the market. While it’s possible that the lagged effect of higher interest rates will start to bite in coming quarters, eventually hurting growth, for the active bond picker, there is a lot of spread on offer. We’ve written about the growth slowdown and the end of the cycle from a credit investor’s perspective here. For those investors who have high conviction and can take an active approach that looks beyond the credit indices, there could be tasty spread opportunities hiding behind the averages.

Figure 2. Distribution of High Yield Bonds by Spread

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Source: Bloomberg, ICE BofA Global High Yield Index as at 30 June 2023.


(With contributions from Sriram Reddy, Managing Director – Credit, Man GLG).

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