Navigating fixed income opportunities across the high yield spectrum

Held in the wake of last year’s 50th anniversary of the Bloomberg Index – the global family of industry-leading Bloomberg fixed-income indices – the Future of Income conference convened some of the world’s foremost innovators and fixed-income experts. The event focused on exploring the transformative changes reshaping this critical asset class.

In a session titled “High Yield Spectrum: Opportunities Across High Yield, Leveraged Loans, and Private Credit,” Noel Hebert (Global Director of Fixed Income, Currency, and Commodity Strategy, Bloomberg Intelligence) moderated a discussion with Brad Rogoff (Managing Director & Global Head of Research, Barclays),  Curtis Lueker (Managing Director & Head of Direct Lending, Marathon), and  Marcel Benjamin (Strategist – ETF Group,  State Street Global Advisors). Together, they examined the opportunities emerging from the rapid growth of emerging segments such as private credit.

With both high-yield spreads and leveraged loan discount margins remaining tight, what’s the outlook for the high-yield space?

Overall, high-yield bonds remain attractive, although the recent rally has narrowed the gap as most assets are relatively expensive. This means the focus has to be on relative value, which is why investors have been shifting from investment-grade (“IG”) to high-yield (“HY”) bonds, especially as IG spreads have tightened to their lowest levels in two decades. In contrast, the current HY market offers better credit quality, lower dollar prices, and shorter durations relative to historical norms. In the HY space, “there would need to be several rate cuts for HY to outperform loans, and we don’t see that happening given the tight levels of corporate spreads ” says Rogoff.

How do the current characteristics of the high-yield market help validate current levels?

Several factors suggest the HY market has yet to exhibit late-cycle behavior. “Credit quality remains strong, with approximately 50% of the HY market composed of BB-rated bonds, up from 40% historically,” says Benjamin. The proportion of CCC-rated bonds – the lowest credit quality in the HY market – stands at around 12%, with issuance running at half the historical average. Meanwhile, the average maturity of bonds in the Bloomberg index remains solidly below par, implying lower refinancing risk. Collectively, these factors suggest the HY market is in a relatively strong position despite a volatile interest rate environment.

How is the current rate backdrop affecting the private credit and direct lending markets?

Both the private credit and direct lending markets are seeing notable shifts as easing interest rates and competitive pressures impact pricing, spreads, and deal activity, especially in the private equity space. Lower funding costs, spurred by recent and anticipated rate cuts, are fueling an uptick in M&A activity. Meanwhile, spreads for clean deals have narrowed to around SOFR + 500–600 bps, while upfront fees have softened to 1.5–2.25 points. “While our focus remains private equity-backed companies with EBITDA between $15 million and $50 million, we keep an eye on the upper middle market where pricing and terms are more aggressive,” says Lueker. Despite these pressures, private credit continues to draw significant interest due to its ability to adapt to evolving market conditions.

Given the growth of the private credit market, which is now valued anywhere from $400 billion to over $1 trillion, how do you see its evolution influencing the broader financial landscape?

Robust investor demand has attracted significant capital inflows into private credit, but subdued M&A activity has constrained deal supply. As M&A rebounds, private credit spreads are widening while banks are regaining ground in the upper middle market after the resolution of many “hung deals.” Meanwhile, the LBO market is heating up as original issue discount costs worsen for private credit, creating a substitution effect where issuers may opt for high-yield bonds or loans instead.

“Where there’s competition, both the spread and the covenants come out of it,” says Lueker. This dynamic denotes a market in transition, where competition and innovation create opportunities for all market participants. For smaller middle-market companies, private credit remains dominant, while in public markets, the liquidity premium is dissipating, thanks to portfolio trading and ETFs. However, “it’s different in Europe where the high-yield market retains a liquidity premium due to the underdevelopment of ETFs,” Rogoff notes.

How are market participants adapting to the growing role of portfolio trading and ETFs?

Client demand is reshaping the fixed-income ETF landscape. The sector has surpassed $200 billion in inflows, with U.S. high-yield ETFs amassing $90 billion in assets. CLO ETFs have seen assets more than double this year, nearing parity with loan ETFs, reflecting a growing appetite for high-grade exposure over below-investment-grade options. “Customization and active strategies are gaining traction as investors explore alternative approaches,” says Benjamin. While narrowing high-yield spreads have tempered enthusiasm, the market’s shrinking size signals a structural shift driven by competition from loans and private credit.

The evolution of portfolio trading and ETFs has fostered a new ecosystem enhancing both market efficiency and liquidity. Portfolio trades often hedge with ETFs, while ETFs rely on portfolio trading for liquidity and execution strategies. CDX remains an efficient tool for short-term credit positioning, but banks increasingly turn to ETFs for managing cash risk, leveraging create-redeem mechanisms to offset exposure. Previously illiquid HY bonds now trade with minimal liquidity premiums, highlighting ETFs’ transformative role in market accessibility and transparency.

Given that we’re currently seeing the lowest default rates in years, how should we assess the potential risks in a higher-rate environment?

Loss rates in private credit are rising, with defaults concentrated in the upper middle market. “Loss rates have climbed from 70 to 80 basis points recently and could reach 120 basis points,” Lueker said, attributing the increase to liability management exercises. Increasingly firms are addressing these challenges via tailored capital solutions like first-lien loans, mezzanine financing, and PIK notes. Meanwhile, default rates vary depending on definition. “If defaults mean bankruptcies or payment failures, they’re relatively low. But when liability management is factored in, rates are above average,” said Rogoff. At the same time, better coordination among lenders makes it difficult for companies to engage in managed defaults.

What are the prospects of a secondary market for private credit to develop given the increasing prominence of private credit-focused instruments?

The potential for a secondary market for private credit is gaining traction, as evidenced by the recent closing of a $3.8 billion direct loan involving 21 lenders. The size of the group suggests that some lenders may seek future liquidity, likely from outside the original lender pool. Although scale is expected to lead to enhanced tradability, the market remains rooted in privately negotiated transactions due to the complexities inherent in multi-party deals. As private credit grows, the secondary market may expand but liquidity is likely to remain marginal.

What is driving the growth in partnership between private credit firms and banks?

Facing sharp competition from private credit, banks are entering partnerships to regain market share. These collaborations typically involve banks originating transactions that are then underwritten by asset managers, who raise capital for the deals. In return, banks earn fees while continuing to serve their core clients. These partnerships allow banks to navigate the regulatory pressures and increased capital charges for leveraged loans. Some partnerships take on more unique forms, where banks and private credit firms co-originate transactions.