BlackRock leads as major investors cut exposure to risky credit as spreads hit historic lows

Big investors are backing off riskier credit after a record run that left debt markets looking stretched. BlackRock, M&G, and Fidelity International are all cutting exposure to lower-rated corporate bonds, moving into safer assets as US credit spreads shrink to near crisis-era lows, according to the Financial Times.

This retreat comes amid growing fear that years of easy gains could unravel fast if global growth weakens.

The problem is simple: the reward for taking risk has nearly vanished. Credit spreads (the extra yield investors earn on corporate bonds over government debt) have fallen to about 0.8 percentage points, down from 1.5 points in 2022.

Mike Riddell, a fund manager at Fidelity International, said “credit spreads are so tight that there’s almost no ability for them to tighten further.” He warned that if anything shakes markets, “spreads can widen substantially.”

Fidelity now holds a short position against developed market credit, a defensive bet that profits if riskier bonds drop, said Mike.

BlackRock adds caution as rally stretches thin

At BlackRock, Simon Blundell, co-head of European active fixed income, said “relentless tightening” has pushed the world’s largest asset manager to buy safer, higher-rated and shorter-dated debt. He called the current setup a “Goldilocks scenario” built on expectations of steady US growth and rate cuts by the Federal Reserve, but one that offers poor risk/reward balance.

The tightening has become so extreme that in some cases, credit spreads have turned negative, meaning investors are getting paid less for holding riskier debt than for owning government bonds.

Bulls say this is justified by stronger company balance sheets and confidence that Donald Trump’s White House will keep policy supportive while the Fed delivers four more quarter-point rate cuts by the end of next year. But even that optimism is fading fast.

Spreads have already begun to widen slightly after US-China trade tensions resurfaced and auto-parts supplier First Brands Group collapsed, rattling sentiment across the credit market.

Paul Niven, who runs the £6.4 billion F&C Investment Trust, said his team recently cut its position in credit to “neutral,” dumping high-yield bonds because “the asymmetry in terms of cost compared to government bonds is getting expensive.” It’s a clear signal that money managers no longer see value in stretching for yield.

Investors retreat from risky loans and weaker issuers

The caution is spreading beyond bonds. Several leveraged loans have been pulled in recent weeks as buyers walked away. A $5.8 billion deal from chemicals producer Nouryon and another worth over $1 billion from drugmaker Mallinckrodt were both scrapped.

Some existing loans have also dropped in price as traders flee to safer assets, and hedge funds are steering clear of shaky borrowers.

Andrea Seminara, chief investment officer at London-based Redhedge, said, “Not only is the corporate credit market way too tight, it’s also equivalently tight between companies. There is lots of idiosyncratic risk which is completely unpriced.”

That’s trader-speak for warning that too many investors are ignoring differences in company strength.

Despite the jitters, not everyone is abandoning credit entirely. Ben Lord, a manager at M&G Investments, said, “Corporate bond yields are attractive and deserve to be owned now.”

The overall yield on corporate bonds received by investors, known as the “all-in yield”, is still seen as attractive by many, due to rises in government bond yields in recent years. The yield to maturity on US investment grade bonds is around 4.8%, according to data from NYSE’s ICE.

Even so, Ben said M&G is rotating into covered bonds issued by life insurers and higher-rated corporate credit, calling the “cost of switching out of BBB-rated unsecured bonds and buying these as low as it’s ever been.”

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