Darpan Harar

After a strong run for global credit markets in 2025, investors heading into 2026 face a more complex and selective environment.  Credit markets delivered robust total returns last year, supported by tightening spreads that ended 2025 near 10-year lows in some segments. However, with valuations now stretched and the risk of spread normalisation rising, investors will need to work harder to protect capital and generate returns.

Darpan Harar, Portfolio Manager, Multi Asset Credit: “Credit markets delivered robust total returns in 2025, after shrugging off short-lived wobbles around political risk. If spreads widen and revert to more ‘normal’ levels this year, investors could see these gains eroded – that’s an important risk to navigate.” 

Credit still offers income, but not all yield is equal

While government bond yields remain elevated, volatility and growing concerns around public finances have undermined risk-adjusted returns in sovereign markets. Against this backdrop, credit continues to offer an attractive source of income — provided investors are selective.  Justin Jewell, Portfolio Manager, Multi Asset Credit: “Credit still offers a great source of income, which is a key driver of long-term investment returns, but not all yield sources are equal.”

Rather than narrowing opportunity sets, selectivity requires casting a wide net across global credit markets, including specialist areas that may offer diversification and protection against interest-rate risk.  “By exploring specialist areas of the market, investors can limit their exposure to interest-rate risk relative to more mainstream markets,” Jewell noted, highlighting the role of floating-rate structures in an uncertain monetary policy environment.

Systemic risks remain contained, but fundamentals matter

Recent high-profile stresses in parts of the US private credit market have raised concerns about broader systemic risks. These pressures remain contained and are largely explained by excesses built up during the leverage buyout boom of 2020–2022.

“We do not think this is a systemic issue,” Harar continued. “Stress has been relatively contained and is largely explained by a hangover from the leverage buyout boom.”  Public credit markets present a different picture. Despite becoming more expensive, areas such as high yield have generally maintained stronger average credit quality, with the riskiest lending increasingly taking place outside public markets. Even so, careful analysis of underlying fundamentals remains essential given the wide dispersion in creditworthiness.

Shifting supply and demand will increase dispersion

After several years of supportive technical conditions, supply-and-demand dynamics are set to change. Increased issuance — particularly linked to investment in artificial intelligence — will lift supply, while a fall in yields may dampen demand.  With credit spreads anchored at historically low levels, this combination points to higher volatility in parts of the investment-grade market. More favourable technical conditions are expected to emerge in specialist areas such as loans, bank capital and selected segments of the high-yield market. 

Positioning for a more demanding year ahead

As the era of “easy income and capital growth” draws to a close, credit investors will need to work harder. Tight spreads mean mainstream credit indices are likely to disappoint, while divergence across sectors and issuers is set to increase.

“A key characteristic of the environment in 2026 is likely to be increasing divergence across economic sectors,” Harar concluded, pointing to shifting consumption patterns and a widening gap between winners and losers across the corporate landscape.  This divergence creates a rich opportunity set for bottom-up investors. Portfolios are best constructed around a core of high-yielding issuers with defensive characteristics, while remaining active and flexible in capturing opportunities as they arise across the global credit universe.

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Darpan Harar

Credit markets continued to be characterised by a tug-of-war between attractive all-in yields and historically tight spreads in Q1. But Trump’s tariff announcements have driven spreads wider. Caution and a careful eye on fundamentals are key, according to Multi Asset Credit Portfolio Manager Darpan Harar.

For many months, strong fundamentals have provided a useful underpin to credit markets, but unprecedented demand has been the key driver of spreads compressing – making valuations perilously high in some traditional market segments. While this backdrop continued in Q1, trade tariff-related concerns had already begun to make an impact, with spreads widening across investment-grade and high-yield markets.

Unsurprisingly, the biggest moves in credit markets came post-quarter end, after President Trump’s “Liberation Day” tariff announcements. Following the news, markets have been highly volatile, with credit spreads widening materially across credit asset classes.

Darpan Harar, Multi Asset Credit Portfolio Manager: “Concerns over the global growth outlook and uncertainty around the impact of tariffs have driven a significant repricing across credit markets, with credit spreads in traditional markets, such as US high yield, materially wider than at the start of the year.”

The speed of recent market moves is remarkable. For instance, spreads in the US high-yield market have gone from being historically tight (5th percentile) to a more reasonable level (50th percentile) – Figure 1.

Forecasting the ultimate level of tariffs and quantifying their eventual impact on the global economy remains highly challenging. However, the near-term impact on the outlook for growth is unambiguously weaker, and the likely inflationary impact creates uncertainty over the outlook for monetary policy. Corporates will struggle to make decisions over investment and production in the short term, margin pressure from the tariff pass through is uncertain, and the typical response to this uncertainty is to hire less, produce less and invest less.

Ninety One’s Multi Asset Credit team has responded to this uncertain backdrop by generally favouring more defensive areas and domestically oriented sectors, which are less likely to be impacted by trade tariffs.

Harar explains: “Amid this heightened level of uncertainty, it is vital to focus on issuers’ underlying credit fundamentals and on their ability to withstand volatility. Investors must be selective to ensure they limit their exposure to businesses that are likely to face a material new shock to their operating model.”

More broadly, there is still a healthy degree of dispersion between asset classes, both in terms of valuations and fundamentals. Specialist areas of the credit market continue to stand out. Bank capital (AT1s), for instance, is supported by strong fundamentals and favourable demand/supply dynamics; most banks called their AT1s in Q1 and this theme looks set to continue given the extent to which banks have already pre-financed. Even here, though, selectivity is key.

“Overall, we currently prefer higher-quality components of the investment opportunity set.  As risk premia start to rise, we expect new opportunities to begin to emerge over the coming weeks and will be proactive in taking advantage of areas of the market that offer compelling risk-adjusted return potential.” Harar said.

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Darpan Harar

Ninety One’s Multi-Asset Credit team explains that historically expensive valuations coupled with elevated levels of distress mean the high-yield corporate debt market is an unattractive destination today. The team believes investors can find a much better risk-reward trade off in other credit markets.

The portion of the European high-yield debt market trading at distressed levels has risen, yet index valuations are historically high (credit spreads are very tight). There’s a dislocation between market valuations and fundamentals.

The context

This isn’t the first time Ninety One’s Multi-Asset Credit team has pointed out how expensive the high-yield market is in terms of tight credit spreads (see misleading mean^[1] and fat tails and phantoms^[2]).

Darpan Harar, Portfolio Manager, Ninety One: “Excluding crisis periods, the proportion of bonds in the European high-yield market that are trading with a spread in excess of 1000bps (i.e., distressed) is relatively high. Crucially, credit spreads are tight given the currents level of market distress seen today.”

Equally stark is what is driving this higher level of market stress. Typically, a sector-specific theme has caused the ratio to peak (for example, stress in cyclical or commodity orientated sectors). Today, stress appears widespread, with the weakest and most leveraged companies in a variety of sectors – including typically defensive areas such as healthcare and telecoms – being punished in the form of outsized credit spreads.

Harar states: “The abrupt change in interest rate regime of the past few years is to blame for this, driving fear among investors around the creditworthiness of over-stretched borrowers even if they operate in typically stable sectors. “

The conclusion

Investors in European high-yield debt are earning a low credit spread, especially in the context of the relatively high amount of distress in the market. In fact, market distortions mean high-yield valuations are even higher than they appear, for similar reasons to those outlined here^[3].

Harar concludes: “We believe selectivity is key in this environment, and the high level of dispersion seen in credit markets today means investors can find better value away from many high-yield assets. We see a better risk-reward proposition in areas such as structured credit and select parts of bank capital and investment-grade markets, which also offer an attractive income profile and more favourable downside characteristics”.

———-

Notes:
[1] Picture this: The misleading mean
[2] Picture this: fat tails and phantoms in high yield
[3] Ibid.

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A high proportion of the global high-yield market is currently trading at a tighter (more expensive) spread than other parts of the credit market which offer much higher credit quality.

Source: ICE BofA, Bloomberg, JP Morgan, Citi, 31 May 2024.

The percentage is the proportion of outstanding debt within the ICE BofA Global High Yield index that trades at a tighter spread than the headline spread of the respective indices. We use swap OAS and discount margins for Global Investment Grade (IG) and CLOs respectively and compare against Global High Yield (HY) swap option-adjusted spread (OAS). We use the spread over a 5/10yr Treasury blend for Agency MBS and compare against Global HY Government OAS. Global IG and HY data are from the ICE BofA Global Corporate Index (G0BC) and Global High Yield Constrained Index (HW0C) respectively. CLO discount margins are from Citi, and Agency MBS spreads are from JP Morgan.

The context

Unsurprisingly, the tougher backdrop of higher-for-longer interest rates has resulted in stress (significant widening of spreads) in some of the lower-rated segments of the high-yield market. We have previously discussed how this was inflating headline index spreads to make the high-yield market appear more attractively valued than it really is. This distressed tail, in part, explains why many investors have been crowding in the higher quality segments of the high-yield market.

Darpan Harar, Portfolio Manager, Ninety One: “For the many investors in benchmark-relative high-yield strategies, the only place to turn to is the highest-rated area of the high-yield market, BB rated bonds. As a result, a widespread preference for quality has driven credit spreads in this part of the market to very expensive (tight) levels, particularly in relation to other – much higher quality – credit markets”.

As the charts show, nearly 10% of the global high-yield index is trading at tighter levels than the global investment grade index, and almost half of the index is tighter than European single-A rated CLOs. In both cases, these are close to decade highs. Perhaps most surprisingly, 18% of the global high-yield market has tighter spreads than those available on newly issued Agency mortgage-backed securities (MBS). Considering that Agency MBS are guaranteed by Government Sponsored Enterprises (GSEs) and are therefore deemed to have comparable credit risk to US Treasuries, this is particularly striking. However, it is also important to note that Agency MBS are trading at very elevated spread levels due to the US Federal Reserve reducing its MBS holdings, and the market pricing in high uncertainty around future mortgage prepayment rates.

The conclusion

Investors with benchmark-relative high-yield debt investments are paying a significant premium in their pursuit of quality. Higher quality assets can be found elsewhere in the global credit opportunity set and, perversely, these are now offering similar if not higher credit spreads. For instance, both the global investment grade market and European A rated CLOs have a rating that is significantly higher than the global high-yield index and are paying the same if not more spread than a material proportion of the global high-yield index.

Harar concludes: “The benefits of an unconstrained approach to credit investing, which allows much greater flexibility in how to achieve an increase in credit quality, has rarely been starker.”

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