Today’s credit markets look deceptively dull: while average spreads are tight, dispersion across issuers is unusually wide. That combination reshapes where returns come from. The lesson for investors? Adapt to prevailing market conditions: when credit beta is scarce, it’s time to focus on alpha from security selection. These are the environments where systematic approaches shine brightest.
Credit Markets Point to a Shift in Return Drivers
Currently, we see geopolitical risk increasingly transmitted through energy markets, raising uncertainty around the outlook even as credit spreads remain tight. While the backdrop for fixed-income markets still looks encouraging, we think now is not the time to seek alpha through big bets on credit.
Meanwhile, several factors are combining to heighten credit-spread dispersion and make individual credit selection more important—especially in sectors impacted by AI competitive disruption, cash burn or resource demands. That’s why we think dispersion of issuer returns will likely increase across credit sectors, creating a timely opportunity for generating alpha through security selection.
We think the best way to capture these opportunities is through an investment strategy that focuses on bottom-up security selection—such as systematic fixed-income investing. Because a systematic approach relies on different performance drivers, it typically generates return streams that are complementary to traditional fixed-income strategies, making it a good bond-portfolio diversifier. But in a security-selector’s market, systematic strategies can come into their own.
Looking Closer to Reveal Hidden Opportunity
At the beta level, average credit spreads are important for determining how well bond-market risks are being compensated. But in terms of prospective alpha from security selection, spread on its own isn’t predictive.
For example, in mid-2014, US high-yield spreads were tightly grouped around their mean; by contrast, issuer spreads are widely dispersed today—even though average spreads were similar in both periods (Display).
