This article has been authored by the following members of Wellington Management’s Fixed Income team: Campe Goodman and Rob Burn, both Fixed Income Portfolio Managers and Raina Dunkelberger, Investment Director.
Geopolitical conflict and AI-related equity market volatility have increased uncertainty, but this backdrop is beginning to create pockets of opportunity across credit markets. For multi-asset credit portfolios, this environment may favour a global, flexible approach that can selectively allocate across public fixed income markets as valuations shift. In our view, a research-driven and dynamic approach will be key to navigating the path ahead.
Market volatility has picked up sharply in the wake of the Middle East conflict and growing concerns about AI disruption across a range of industries. In response, credit investors have shifted to a more cautious stance, as evidenced by modest spread widening and a greater focus on liquidity. Worries about the inflationary risk posed by surging oil prices have also pushed government bond yields higher and reduced market expectations of near-term policy easing.
Within credit markets, the repricing has been uneven. Leveraged loans have experienced meaningful price pressure, reflecting both their sensitivity to broader risk sentiment and the loan market’s significant exposure to technology and software issuers. High-yield bonds and convertibles have also weakened alongside equities, albeit to a lesser extent.
Importantly, the recent moves appear driven largely by technical and sentiment-related factors rather than a broad deterioration in corporate fundamentals. Many issuers entered this period with manageable leverage and adequate liquidity, meaning that as dispersion across sectors and issuers is beginning to widen, opportunities may be opening up for active credit investors.
Periods of market volatility can create opportunities when valuations adjust more quickly than underlying fundamentals. At this stage, we see emerging opportunities across three markets:
Global high-yield bonds
High-yield markets were significantly affected by the technology sector correction, with software issuers among those most heavily repriced. In some cases, the market reaction appears to have been driven more by broader risk sentiment than by issuer-specific deterioration. We believe this potential overcorrection may have created idiosyncratic opportunities, where current yields may offer attractive compensation for credit risk. From a regional perspective, we see more attractive valuations in Europe compared to the US, particularly when adjusting for differences in sector and rating composition. The European high-yield market is more domestically focused, with much of the issuance coming from the utilities and services sectors. European issuance also tends to have higher ratings compared to the US. We expect this overall more defensive composition to further reduce the impact of exogenous global shocks.
Leveraged loans
Leveraged loans have experienced their steepest monthly decline since September 2022, as significant exposure to technology and software issuers (roughly 20% at the time of writing) has amplified the impact of the broader equity sell-off.
As a result, dispersion across issuers has widened to the point where we think valuations for some credits may have fallen meaningfully below their intrinsic value. In our view, this environment may create opportunities to selectively add exposure to issuers with durable business models.
Mezzanine CLOs
Mezzanine CLO tranches (collateralised debt tranches typically rated AA to B) have been relatively resilient so far and, in our view, may not yet fully reflect the possibility of a broader slowdown in the economy and credit cycle. This stands in contrast to the underlying leveraged loan market, where prices have already begun to adjust to higher default expectations. Because mezzanine CLO tranches are ultimately collections of leveraged loans, they remain sensitive to tail risks in the leveraged loan market should credit fundamentals deteriorate, although structural protections and diversification within CLO portfolios can help to mitigate some of these risks.
Energy prices are another factor to monitor. While higher oil prices could pressure certain sectors such as transportation and consumer discretionary, CLO exposure to energy issuers has declined significantly over the past decade, limiting the potential impact of commodity-related volatility. Overall, we believe spreads may need to widen further before the sector presents more compelling entry points. For now, we would advocate focusing on the select instances of potential opportunity that we see emerging.
Several factors will likely shape how credit markets evolve in the coming months:
We think each of these factors can create meaningful opportunities for investors, but they may also entail additional risks, meaning discipline and careful credit selection are paramount.
Channel Investment Management Limited ACN 163 234 240 AFSL 439007 (‘CIML’) is the responsible entity for the CC Wellington Multi-Sector Credit Fund (AUD) ARSN 688 887 103 (‘Fund’). The Fund invests in the Wellington Multi-Sector Credit Fund, being a sub-fund of the Wellington Management Funds (Luxembourg) II SICAV (the ‘Underlying Fund’, or together with its affiliates ‘Wellington’).
Neither CIML, the Underlying Fund, Wellington, their affiliates, officers, or employees make any representations or warranties, express or implied as to the accuracy, reliability or completeness of the information contained on this website and nothing contained on this website is or shall be relied upon as a promise or representation, whether as to the past or the future. Past performance is not indicative of future performance. This information is given in summary form and does not purport to be complete. Information on this website should not be considered advice or a recommendation to investors or potential investors in relation to holding, purchasing or selling units in the Fund and does not take into account an investor’s particular investment objectives, financial situation or needs. Before acting on any information, investors should consider the appropriateness of the information having regard to these matters, any relevant Product Disclosure Statement (PDS) and in particular, they should seek independent financial advice. For further information and before investing, please read the PDS and Target Market Determination (TMD) located at channelcapital.com.au.
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