Early this year, US corporate credit spreads narrowed to historically tight levels, as investment grade spreads declined to their tightest level since 1998 and high yield spreads fell to levels last seen ahead of the 2007 cycle peak. Phillip Gronniger, client portfolio manager at Thornburg Investment Management, shares his insights.
Although spreads widened briefly amid recent geopolitical volatility, that move proved short-lived. By the end of April, both investment-grade and high-yield spreads had retraced and remained near the lowest percentiles of their historical ranges.
This backdrop matters because while all-in yields remain attractive, spreads at these levels have historically offered limited compensation for incremental credit risk. Starting points like today’s have often translated into weak or even negative forward excess returns over the subsequent 12 months. The challenge is one of imbalance. Spreads have limited room to tighten further, yet even modest economic softening, policy uncertainty, or renewed volatility could lead to meaningful spread widening and corresponding price declines.
Tight spreads often reflect strong investor confidence and a benign economic outlook. However, they also leave little margin for error. When compensation for credit risk is compressed, the return profile becomes increasingly asymmetric. Investors may collect income if conditions remain favourable, but they face disproportionate downside if fundamentals deteriorate or volatility resurfaces.
Patience and perspective needed
In environments like this, we believe discipline becomes especially important. Rather than broadly reaching for yield, investors may be better served by emphasising higher-quality opportunities where balance sheets are more resilient, and downside risks are better understood. Maintaining flexibility also matters. Tight spreads can unwind quickly, and the ability to respond to market dislocations may create opportunities to add risk at more attractive entry points.
This approach reflects our broader philosophy toward income investing. Generating income remains important, but not at the expense of taking uncompensated risk. When spreads are tight and the margin for error is thin, selectivity, quality, and risk control take precedence over maximising yield.
Periods like today favour patience and perspective. While strong fundamentals may persist for some time, history suggests that investors should be cautious about assuming favourable conditions will continue indefinitely. By focusing on capital preservation, maintaining flexibility, and avoiding areas where downside risks outweigh incremental income, investors can position portfolios more defensively while remaining prepared to act when valuations become more compelling.
