In 2024 credit became exciting again. Higher base rates, combined with healthy company fundamentals and strong consumer spending, meant that credit-focused investment managers were able to deliver robust performance without needing to take on much additional credit risk.¹

Looking ahead to 2025, ample investor liquidity, continued appetite for yield, and general optimism around the U.S. economy make the broader credit markets appear expensive. Idiosyncratic opportunities to seek alpha will persist, though. In this research note we highlight macro themes that we believe could lead to interesting investment opportunities. We also provide a few supporting case studies from our credit manager partnerships and a brief appendix covering the foundations of investing in distressed debt. Key points are summarized below. (Please see our full length report for accompanying charts and data sources, as well as important disclosures).

2024 Recap: Conditions Supported Strong Performance

Higher Base Yields Impact Full Credit Landscape. Piecing together a bond’s total return expectation begins with the yield of the investment, and this foundational element provided a good starting point for 2024. After five to ten years of low rates, higher base yields brought higher expected returns for bond investors across the fixed income spectrum. Core bond funds as well as high yield bond funds benefited as they made new investments at these higher yields. As current investments in their portfolios matured or were sold, fixed income managers invested the cash proceeds in higher yielding bonds, boosting overall portfolio yields and returns.²

Low Default Rates.³ The other foundational element of credit investing is whether or not bondholders will get repaid. Evaluating the risk associated with default is dependent on the mandate of the investment strategy. For example, distressed managers will be comfortable with a higher probability of default whereas an investment grade bond manager would have a lower tolerance for risk. Regardless of an investment manager’s attitude toward risk, low default rates benefited all credit investment strategies in 2024.

Tight Spreads.⁴ 2024 saw historically tight spreads across the credit spectrum, driven by strong corporate cash flow and ample investor liquidity. This dynamic made it hard to find attractive prices and opportunities for capital deployment. The tight spreads within high yield were partly attributable to the improved credit quality as described above as well as government rates coming up on the long end of the curve. Despite the challenges of finding opportunity amid tight spreads, our managers still performed well as higher overall yields and higher bond prices both contributed to returns.

Stressed Situations. Over the last few years, many companies with weaker balance sheets or those that had debt maturing (thus needing to re-issue debt to raise capital to run their businesses) experienced difficulty in paying the higher interest costs. Credit investors that focused on the stressed and distressed bonds of these companies benefited from an increase in the number of these bonds and a greater ability to pick through them to identify the best opportunities to generate returns.⁵ There were multiple ways these investors generated returns given this backdrop such as pull-to-par, amend-and-extend, and loan-to-own strategies. While the details of the above situations are lengthy and complex, the number of occurrences increased as interest rates increased and remained elevated throughout 2024. (Please see Appendix of full report for definitions of the terms above.)

2025 Outlook: When Beta Credit Opportunities Are Scarce, Hunt for Alpha… But Buyers Beware

Entering 2025, idiosyncratic credit opportunities persist. While numerous disparate opportunities will appear in 2025, we have chosen to highlight three categories of macro themes where interesting investments could surface:

1. Crosscurrents in the public equity and credit markets are making obtaining financing for smaller public issuers difficult and expensive. From an individual company’s perspective, it is increasingly attractive to raise capital in the convertible bond market given persistent higher interest rates as well as higher equity volatility.
2. The second theme incorporates a combination of credit market dynamics. A lack of bond covenants and an increased prevalence of balance sheet stress from persistent high rates have given rise to a more adversarial creditor environment.
3. Finally, implications from quantitative tightening are resurfacing. For example, in October this year we witnessed the breakdown of the relationship between credit spreads and interest rate volatility. Though not necessarily a security-level opportunity, our managers are seeking this type of dislocation as a sign of market stress underneath what otherwise seems to be a stable corporate environment. This third category of hidden stress is more difficult to predict in terms of opportunities for our managers. However, we believe they are well positioned to navigate this dynamic, and we plan to remain in close contact with them as 2025 unfolds.

We are excited about the opportunity set for our alpha-seeking credit managers in 2025 even as many investors are hesitant about index level credit metrics. Our managers are keenly aware of the risks to their strategies, and we are confident in their ability to steer their portfolios towards areas of opportunity in order to generate returns for our clients.

Click here to read the full report.