Solving the credit conundrum

Credit investors face a conundrum. On the one hand, the backdrop for credit remains attractive thanks to fiscal tailwinds, accommodative central bank policy and strong demand for the asset class. A surge in AI investment could support continued economic growth, while stubborn inflation is likely to limit policymakers’ ability to cut rates further, keeping yields relatively high in 2026.

On the flip side, valuations across most sectors are now rich, and volatility is conspicuously low. Credit remains vulnerable to potential repricing. And while investors are still being handsomely rewarded for holding credit, the easy opportunities have largely been captured. The beta wave has been ridden. 

We expect 2026 to be another year of overall positive total returns but the conundrum is real. Optimising exposure to the asset class amid potentially major shifts will, in our view, involve greater selectivity and discipline. In the sections that follow, we outline the key forces shaping a rapidly changing opportunity set and share our approach to portfolio positioning for the year ahead.

Keeping a close eye on corporate behaviour

As the cycle matures, the nuances of corporate behaviour and balance sheet discipline become even more important. Robust balance sheets and easy access to capital may increasingly tempt management teams to adopt more aggressive capital allocation techniques, be it through M&A, buybacks or higher gearing, in turn driving greater bond issuance as companies seek to finance transactions.

We are closely monitoring the potential for more aggressive balance sheet management, particularly among higher-quality issuers. At tight valuations, we are comfortable reducing exposure to these issuers, with a view to adding at more attractive entry points. 

Rising dispersion across sectors and regions also underscores the importance of security selection in this environment. We think deep, fundamental research and a disciplined approach will be essential to protect capital and capture relative value as the cycle evolves. 

Embracing a changing credit landscape

The surge in AI-driven capital expenditure is not only transforming the real economy but also reshaping the global credit landscape. We are witnessing a meaningful deepening of credit markets, with new issuers and innovative financing structures. The composition of the universe is evolving rapidly, as public and private credit increasingly shoulder the burden of financing large-scale infrastructure and technology investments. This trend is blurring the lines between corporate and project finance and introducing new complexities for credit analysis. 

These developments undoubtedly bring new risks, such as the lack of clarity on the durability of AI-related investments and the many challenges associated with novel deal structures. However, they also create a broader and richer opportunity set for active, research-driven investors who have the cross-asset-class expertise to decipher this growing bond complexity and identify which projects and issuers are likely to deliver sustainable cash flows and which may struggle as the cycle evolves.

Investment-grade (IG) markets have been a key source of funding to date, with global convertible bonds and private credit serving as the two other main avenues. By contrast, AI issuance in the US high-yield market stands at only roughly 2% and we are currently cautious on many of those issuers as we believe that the rapid build-up in capacity could lead to oversupply, downgrades and, potentially, defaults. For both investment-grade and high-yield investors, such a wave of fallen angels could ultimately provide an opportunity for alpha generation through careful security selection.

Positioning for macro shifts and dispersion

The interplay between the economic and credit cycles is set to define the year ahead. While we are not yet calling a turn in the credit cycle, diverging monetary policy paths, fiscal sustainability concerns and a renewed focus on lending standards all have the potential to trigger pockets of volatility and repricing in public credit markets. Central banks may turn out to be a key source of volatility. As Figure 1 highlights, the number of global rate cuts has already been exceptionally high, and if policymakers reduce rates further despite persistent inflation and strong nominal growth, we could see abrupt market repricing as investors demand higher risk premia.

Figure 1

Given these risks to the economic cycle, we acknowledge that certain areas of the credit market offer limited compensation. For example, we continue to observe a lack of dispersion in the pricing of cyclical versus non-cyclical issuers. With minimal-to-no spread give-up, we have rotated portfolios into areas of the market where we hold higher conviction. Within IG portfolios, we continue to favour sectors and issuers with resilient fundamentals and identifiable positive catalysts, such as European REITs, select utilities and the large “money-centre” banks. Within high-yield portfolios, we remain positive on issuers with strong competitive barriers to entry, in sectors and countries where we do not see an increased risk of defaults, such as packaging companies and software service providers. 

For investors, vigilance will be key — not just in monitoring the top-down macro backdrop, but also in understanding how these forces filter through to credit fundamentals and financial conditions. Flexibility and readiness to adjust exposures quickly will be essential to charting periods of dislocation and capturing emerging opportunities.

Putting insights into action:

• For investment-grade investors, the current environment offers an attractive mix of strong corporate fundamentals, robust technical support and still elevated yields. We are finding the most compelling opportunities in sectors with resilient balance sheets or positive catalysts yet to be reflected in market pricing, while remaining cautious on areas where valuations are stretched or where we see the potential for more aggressive capital allocation. We believe the credit cycle remains robust but we expect some spread volatility and sector and security dispersion that active managers can exploit. 
• For high-yield investors, the combination of attractive yields and a structurally short-duration profile makes high-yield bonds especially appealing for those seeking to manage interest-rate risk or reduce equity exposure. Within the asset class, European high yield still trades at a discount to the US. Furthermore, the quality of the European high-yield market has improved since the debt crisis, and fundamentals remain solid. We expect defaults to stay close to historical norms, as much of the riskier lending has shifted to private credit and leveraged loan markets. This creates a favourable return backdrop for European high yield relative to other regions, particularly when combined with an accommodative macro environment.
• For those with greater flexibility, we see value in flexible or multi-sector approaches. Investors who can comb through the full spectrum of fixed income opportunities and dynamically adjust exposures quickly may be well positioned to capture dislocations as they occur. In an environment where regime shifts and structural change are creating both risks and opportunities, a dynamic approach can help to unlock differentiated sources of return and provide greater resilience against unexpected shocks.