Managing High Yield Credit Amid Volatile Yield Curves

Cash bond yields tempt. The small print is duration. You earn carry, but you also wear a long fuse. When the back end twitches, months of income can vanish in a day. That’s not drama. That’s math. Here’s the uncomfortable truth: most investors don’t choose duration; spreads choose it for them. A tight spread on a long bond feels safe until rates move. Then you find out your “income” was leverage in disguise. If you can’t hold through a rate shock, you didn’t buy yield. You rented risk. Carry you can keep beats yield you can’t hold. I’d rather own short-dated IG with clean balance sheets than stretch for a few extra basis points in long HY with thin covenants. I want duration where I pick it, not hidden inside credit. If I add length, I pair it with liquid hedges and clear exits. Pride doesn’t pay coupons. Cash does. The curve still matters. Front end gives you carry and optionality. The belly can work when cuts arrive on schedule, not hope. The very long bond is a tool, not a home. Use it for a reason: liability matching, a hedge, or a defined trade. Not because the yield looks neat on a slide. Know your DV01. If you don’t know how much a 25–50 bp move costs you, you’re not managing risk. You’re guessing. A portfolio that bleeds on small rate moves won’t be around for the big win. Size like you plan to survive boredom and shock. Credit spreads look calm—until they don’t. They don’t give you a countdown. They gap. If growth cools or policy bites, refinancing risk shows up fast at the weak end. That’s when owning quality feels “boring” right up until it saves the month. Boring is a strategy. Tactics I like now: keep a T-bill sleeve for dry powder. Skew to short IG over long HY. Add a measured belly position where valuations are fair. Use simple hedges instead of cute structures you can’t exit. If volatility is cheap, rent some. If it’s rich, cut size and wait. And remember: income is not a trophy. It’s a stream that needs defense. Rebalance winners. Trim length into rallies. Add only when the tape gives you paid risk, not just risk. The goal is steady compounding, not yield cosplay. Are you choosing duration, or is it choosing you? What’s your portfolio DV01 on a 50 bp bear steepener? Which bonds still pay you for the credit risk? Where would you cut first if the long end jumps? What lets you hold through a bad week without panic? For more see our Nomura CIO Corner: https://lnkd.in/e4TCax_g Appreciate @Tathagata @Anuragh @Dhrumil for the sharp back-and-forth #fixedincome #bonds #rates #duration #yield #credit #carry #treasuries #riskmanagement #portfolio #CIO #Nomura

A lot of talk this morning about how tight credit spreads are and whether this sets the stage for a 2007-style outcome. Bloomberg: "Hottest Credit Markets Since ‘07 Spur Warning on Complacency" Here is how I am thinking about it. Credit spreads are extremely tight, issuance remains heavy, and investors continue to prioritize income over protection. That part is clear. Where the conversation often misses the mark is on why this setup exists and what would actually cause it to change. Tight spreads do not reflect widespread carelessness. They reflect strong, ongoing demand for income in a low volatility environment. Many investors still sit on significant cash and need steady yield to meet obligations. At the same time, the economy has avoided meaningful stress, so default expectations remain low. In that backdrop, credit can stay expensive longer than fundamentals alone would suggest. Comparisons to 2007 are tempting but misleading. Before the financial crisis, risk hid inside complex structures and opaque balance sheets. I lived that firsthand at Bear Stearns. Today, risk sits elsewhere, more in private credit, sovereign balance sheets, and fiscal pressure than in public investment-grade or high-yield corporate credit. On a standalone basis, public corporate balance sheets do not look especially fragile, and that distinction matters. I also think the role of expected Fed rate cuts gets overstated. Credit markets have already priced a supportive policy path. Spreads are not tightening because investors expect lower rates. They are tightening because volatility remains low and carry continues to work. That dynamic differs meaningfully from a rates-driven credit rally. Where I agree with the caution is on asymmetry. At roughly 103 bps, spreads offer little compensation for political risk, geopolitical shocks, or a loss of confidence in institutions. You do not need a recession for spreads to widen. A pickup in volatility or a decline in liquidity would be enough. The real risk is not an immediate credit collapse. The risk is that investors stay anchored to carry and underestimate how quickly conditions can change. When spreads are this tight, exits matter more than entries. Markets tend to look fine until they do not, and when they turn, they often move quickly because positioning crowds the same trades. Bottom line. This is not 2007. But credit markets are priced for stability in a world that increasingly delivers disruption. Carry still works, but at this stage of the cycle, managing downside risk matters more than squeezing out incremental yield.

Mastering Yield Curve Risk: Beyond Single-Factor Models In the real world, yield curves don’t just shift up or down in unison — they twist, bend, and butterfly in ways that traditional single-factor models fail to capture. ⸻ 🔹 Principal Components Analysis (PCA): Analyze yield curve behavior by extracting three dominant moves: • Level (all rates move together) • Twist (short vs. long rates diverge) • Butterfly (mid-term yields behave differently) PCA helps explain most of the variance in rates with just a few factors! ⸻ 🔹 Key Rate Duration (KRD) & Key Rate 01 (KR01): Instead of assuming one move fits all, KRD measures local sensitivity at specific maturities (e.g., 2Y, 5Y, 10Y), while KR01 shows $ exposure to a 1 basis point shift. Real-world application? Fine-tune your portfolio risk by targeting the exact curve segment that matters — not the whole curve blindly. ⸻ 🔹 Advanced Hedging Techniques: Construct precision hedges by: • Calculating portfolio KR01s • Choosing instruments with offsetting KR01s • Solving for a neutralized exposure Especially critical for barbell portfolios, swap books, or portfolios concentrated at specific curve points. ⸻ Bottom Line: In today’s dynamic markets, granular risk management beats broad assumptions. If you’re still relying on parallel shift models, you’re missing half the story. It’s time to think in key rates, factors, and exposures — not just yields. #RiskManagement #FixedIncome #YieldCurve #PCA #Hedging #InvestmentStrategy #PortfolioManagement

When Pondering Spreads, Focus on Absolute Returns IG and High Yield spreads are trading at their tightest levels in 20 years. The trader is hesitant to invest when spreads are tight. The investor, however, recognizes that the absolute yield is at its average return over the past 2 decades. As I discussed in my post last week, I expect spreads to be locked in at tight levels in 2025 as earnings, GDP, and credit worthiness remain robust. Despite the Fed lowering rates, longer-term rates remaining “higher for longer” allowing investors to earn a relatively attractive current yield. US IG, High Yield and BSL outperformed their counterparts in Europe in 2024, and I expect a repeat in 2025, as does UBS as shown in the bar chart below. If HY and BSL can earn 7%+ in 2025 as UBS and I expect, that is pretty good given how tight spreads are. Remember that spreads are tight for a reason - credit conditions are improving. I believe default rates will decline dramatically in the coming year, but with over 2,000 credits in the US alone, credit selection is critical for performance. Special Note 1: While credit markets have a green light, the most important caveat today is to avoid companies that rely on Chinese imports for manufacturing/supply chain - increased tariffs are coming by Q2 ’25, and companies who primarily source from China, will begin to feel it, in certain cases this impact could be equal to a company’s entire operating margin. Special Note 2: We should recognize that UST risk represents a tail risk, with massive issuance on its way, a condition which adds duration risk and will most steepen the yield curve - I plan to elaborate on this in the coming days. Short duration structured credit remains highly attractive, it offers greater than +100bp pick-up relative to corporate credit with favorable tailwinds with room for spreads to tighten further. Marathon Asset Management has identified terrific value in RMBS, ABS and CLOs, with the greatest alpha extracted in the CMBS market given the huge divergence in credit scores throughout the CMBS complex. I am bullish CMBS as I turned bullish on CRE over the summer, however, not all boats will get the lift since many are too damaged. This is precisely when a great credit manager can earn its stripes. Of course, for those that can invest in Private Credit, there is a huge value proposition to gain with +300bps of excess return relative to public markets, but sourcing and investment judgement is everything. Too much money has been raised and many are too slow to deploy. For those with robust sourcing channels, it’s the best value proposition in my belief.

High yield credit spreads are tight. At the time of writing, the US index trades at a spread of 279 over Treasuries. This is not the tightest on record but the reward for taking additional credit risk is historically slim. Taking the view that spreads are rich is easy; however, knowing what to do about it is much more of a conundrum. Despite high yield valuations looking optically expensive there are plenty of reasons why investors might still be comfortable holding. Let’s consider some of these arguments: Credit spreads are ‘always’ tight: Spreads are certainly not normally distributed – they spend a lot of the time appearing rich until they don’t. Credit spread levels are a terrible timing tool: This is true, but what isn’t? Credit quality has increased: Perhaps, but have expected through cycle default rates decreased enough? Being underweight high yield is a ‘pain trade’: For a relative return investor being underweight high return / carry assets is always hard.   High yield is a structurally attractive asset class: It does have compelling long-term features from a portfolio perspective. Corporates are more attractive than governments: Don’t underestimate the power of being able to print the currency in which you issue debt. — Credit spreads are unequivocally tight, but there are a range of reasons as to why that might be palatable. What could investors do? Do nothing: Perfectly sensible, but does this apply at any spread level? Reduce exposure and increase credit quality: It is always tough to underweight carry and lower long-run expected returns. Find a replacement asset with similar risk levels: Maybe, but most (all) spread assets look richly priced. Use more active strategies: Perhaps it is a ‘credit pickers' market!’ Create a mix of assets to replace high yield: High yield exposure is like owning a government bond and selling an equity put option, so why not a government bond plus an undervalued equity market. (Not as easy as it sounds). — There is no right answer to the question of narrow high yield spreads. Our own approach will come down to a multitude of factors including our objectives, philosophy and behavioural tolerance for underperformance. --- A more detailed version of this piece is available in the comments.