According to Thornburg Investment Management, the premium investors require for credit risk, known as credit spreads, has continued to narrow for the past three years, despite a rise in loan delinquencies and corporate bankruptcies. The firm highlighted that even as defaults have increased, spreads on corporate credit have moved tighter, with Ba-rated high-yield bonds now priced near the historic spread levels of investment-grade Baa debt.
The Market’s Tightest Window
In its analysis titled “Fortune Favors the Disciplined,” Thornburg observed that Ba-rated junk issues are currently trading at the long-run average spread associated with Baa-rated investment-grade securities. Conversely, B-rated obligations are aligned with the historical average spread for Ba-rated debt, the report indicated. This compression leaves market participants with reduced protection, as the underlying default risk remains present, Thornburg warned.
Should spreads revert to more typical widths, the study projects that holders of high-yield bonds could forfeit as much as 1.5 years of expected earnings. Since 1994, bonds rated Baa have experienced defaults in over 40% of calendar years, while speculative B-rated issues have recorded at least one default in each of the past 31 years, according to the data.
Managing the Risk
Thornburg also identified a divergence between risk indicators and bond pricing. The Economic Policy Uncertainty Index has risen steadily over the last 18 months and now sits close to its peak observed during the pandemic. Yet, instead of expanding, credit spreads have continued to contract, a pattern that runs counter to the usual relationship between these metrics.
Christian Hoffmann, a co-author of the report and Thornburg’s head of fixed income, also oversees the Thornburg Core Plus Bond ETF (TPLS). The actively managed fund debuted on February 4, 2025, and began with $14.65 million in assets under management. Thornburg structures TPLS around a single principle: assume risk only when the associated yield adequately rewards it. The report states that this disciplined mindset is largely absent from today’s spread environment.
According to Thornburg, the fund steers clear of chasing extra yield by moving into lower-rated corporate paper. Instead, it employs a flexible, unconstrained strategy across various durations, sectors, and security types to uncover relative value. As of August 31, collateralized mortgage obligations and asset-backed securities together comprised almost 30% of the portfolio, whereas the Bloomberg U.S. Aggregate Index benchmark holds virtually none of these assets.
The same disciplined approach is reflected in the fund’s diversification across 345 separate securities, Thornburg reported. Its largest individual holding, a U.S. Treasury strip, accounts for only 8.32% of total assets, with the remainder allocated among corporate, agency, and asset-backed obligations.
Leave a Reply