What can we expect for fixed income at this time?
I think overall the environment is quite positive, especially for credit. The US economy is performing well and, so far, we have not seen a significant impact from the tariffs. Additionally, the current third quarter earnings season is expected to be quite strong.
Inflation will be one of the big factors to monitor for next year, as well as the possible delayed effects of tariffs. If we analyze corporate fundamentals, they remain very solid, both in terms of interest coverage and leverage ratios.
In the primary market, recent months have been especially active, with some of the highest issuance volumes in the high yield. Companies are proactively addressing the so-called “maturity wall,” not only in 2026, but also in 2027 and 2028. Therefore, default rates are expected to remain at low levels over the next 12 months in this segment.
In terms of valuations, spreads are tight, but total returns remain attractive. It is, therefore, a market highly driven by carry. We believe that, over the next 12 months, performance will come primarily from that coupon yield and less from further tightening of spreads. For active managers, we consider that it will be an environment more based on the generation of alpha that in the beta of the market.
Where do you see investment opportunities in this scenario?
We see certain pockets of value in the segment crossoverthat is, in loans with a rating between BBB and BB, as well as in subordinated financial debt from selected issuers. We also identified some idiosyncratic opportunities in both emerging markets and the high yield segment.
One aspect that we are following very closely in the fixed income universe is the high volume of liquidity in US monetary funds, which currently amounts to around $7.4 trillion. Over the last 12 months, that number has increased and these funds are returning around 4%, which is a positive real return as inflation in the US is around 3%. However, as the Federal Reserve begins to cut rates this year – and possibly next as well – we could see money fund yields decline towards levels close to 3%. Therefore, we are attentive to the possibility that part of that capital seeks higher returns in riskier assets, such as corporate credit. If this happens, we believe that the crossover segment and certain short-duration high yield strategies would be the main beneficiaries.
Perspective on high yield
The interesting thing about the high yield market this year is that we are observing a phenomenon of a certain “decompression” in spreads. This is unusual, as in a strong market environment we typically see compression, meaning lower quality loans tend to perform better than higher quality ones. However, the opposite is now happening. This reflects that investors want to take advantage of the attractive returns offered by fixed income, but at the same time seek to avoid possible “mines” in the market.
As for defaults, rates remain at very moderate levels: in American high yield, the default rate for the last 12 months is around 1.4%, while in Europe it is around 3.5%, although this percentage is mainly due to some specific cases of large capital structures. Furthermore, recovery rates have been high, so net credit losses are quite limited. Our view is that default rates will remain contained over the next 12 months, thanks to overall solid fundamentals and a well-managed maturity schedule, as many companies have already refinanced debt maturing in 2026. In this context, high yield continues to offer good carry, but credit selection becomes a crucial factor. It is a market where the differentiation between “strong” and “weak” issuers will clearly make the difference in results.
Outlook on emerging market debt
Emerging market debt has had a very positive performance so far this year. Part of this good performance is due to a genuine improvement in fundamentals. We are seeing a significant wave of upward revisions in credit ratings, especially among emerging sovereigns. Furthermore, external conditions in many countries are improving, which reinforces this underlying positive trend. Another relevant aspect is the behavior of the flows. After three consecutive years of capital outflows, this year we are again seeing net inflows into emerging markets, which could continue and provide additional technical support to this asset class.
However, as in the high yield segment, this is an environment in which credit differentiation is key. It is not about buying the entire index, but about carefully selecting the right issuers and avoiding potential hidden risks. In short, it is a very favorable context for active managers capable of distinguishing between winners and losers within the highest risk part of the market.
Why a flexible portfolio like Vontobel Credit Opportunities?
Firstly, this product benefits from the knowledge and experience of the entire Vontobel fixed income boutique. We work very closely with the different portfolio management and credit analysis teams within the firm. One of the key features of this strategy is that it is benchmark agnosticthat is, it is not subject to a reference index. This allows us to not be forced to invest in the big names that dominate the indices, which are often companies with high levels of leverage. In our case, we only enter this type of issuer when, after a value correction, we find a real opportunity.
In addition, the strategy has access to practically the entire public credit universe: from emerging market sovereign and corporate debt in hard currency, to investment grade and high yield credit in developed markets, including the financial sector. This broad approach not only captures more opportunities, but also mitigates the risk of one segment of the market performing significantly worse than another, creating natural diversification.
Another important aspect is that, by covering so many segments, we obtain very valuable signals from different parts of the market, since not all segments move at the same time. This asynchrony opens up opportunities for relative value and provides us with useful information to adjust the portfolio.
Historically, this strategy has had a high turnover—around 300%—which reflects its dynamic nature. We believe volatility could increase over the next 12 months as spreads are at tight levels and tail risks remain elevated. In that context, a flexible and active strategy like this can benefit significantly. Traditionally, approximately 60% of profitability comes from carry and 40% from capital appreciation, and an environment of greater volatility opens up more opportunities for rotation and value generation through capitalization.
How is your portfolio positioned? What have been your latest movements?
In the current environment we pay close attention to the underlying liquidity of the portfolio. We want to maintain a high level of liquidity so we have room to maneuver and be able to quickly rotate into oversold securities should volatility pick up again. Therefore, the portfolio is currently structured in a very liquid way.
We have exposure to products linked to CDS (credit default swaps), which we consider as a synthetic long position in high yield. The advantage of these types of instruments is that they can be traded much more cost-efficiently than traditional bonds.
Furthermore, the portfolio is positioned relatively defensively compared to its history. More than 25% is invested in rated issues A or higher, mainly in short-term bank bonds. This position acts as a liquidity cushion against our long exposure in CDS. Both segments can be liquidated quickly if volatility increases or clearer value opportunities arise in the market.
On the other hand, around 40% of the portfolio is invested in credit crossover —securities rated between BBB and BB—both from the financial and corporate sectors, where we still see a certain attractive differential in relation to fundamentals. On the other hand, exposure to the weakest part of the market is minimal: the allocation to CCC bonds barely reaches 1.5%. This reflects our caution towards the lower credit quality segment, especially given the current bifurcation process and the fact that some high yield capital structures – conceived during the zero rate era – are being questioned. Ultimately, we prefer to stay away from excessively leveraged companies in the current context of higher interest rates.