5th December 2025
Being based in Devon, there is a never-ending debate with the Cornish about scones – is it jam first or cream? While based in Devon, I’m originally from Hampshire and my view is a simple one – I’m happy so long as there is a thick spread of both!
In recent months, there has been a seemingly never-ending debate in fixed income markets about a different type of spread – namely the additional yield investors are getting from taking credit risk, and especially the lack of it compared with history. There is less debate about this type of spread across the Devon / Cornwall border, but it’s just as interesting to us!
Right across the fixed income universe whether it is by asset class (investment grade, high yield, emerging market debt – both sovereign vs developed markets and corporate bonds, and asset backed securities) or by credit rating buckets within asset classes, however you cut and dice it there is very little spread to go around.
Why are spreads everywhere so tight?
There are a whole host of reasons, but the most compelling starts and ends with the attractive all-in yield fixed income markets currently offer relative to recent history. High all-in yields are attractive to pension funds and insurance companies (especially those that are liability matching) who will indiscriminately buy once a certain yield level is reached, regardless of the credit spread. Higher yields themselves provide defensive attributes by providing a bigger cushion when risk off events happen, especially for bonds with low-interest rate sensitivity (duration).
What it means is that today most of the return available from passively owning the asset class is coming from the government bond “risk free” component of returns. Given that, why bother taking on additional credit risk at all and should you just park your entire fixed income exposure in sovereign debt? There are a few observations we would make.
Fixed income markets continue to offer great opportunities and inefficiencies that active managers can exploit to enable them to deliver returns in excess of those available from passive exposure to the asset class.
The first is valuation dispersion, whereby although spreads at an index level look tight, under the surface there is a lot of opportunity with large parts of the market offering spreads much wider than the average that an active manager can carefully exploit to enhance the return prospects of the portfolio.
Secondly, a lot of fixed income investing is rules based: a large cohort of fixed income investors can only own bonds with specific credit ratings, and when those ratings change they become forced sellers or buyers creating opportunities for nimble active managers in the ‘crossover’ space, a niche where one of our favoured bond managers Peter Harvey at Schroders has built a long and successful career.
Another avenue is through trading strategies like that implemented by Lloyd Harris at Premier Miton. New issuances often come slightly above existing credit curves creating short-term arbitrage opportunities and small alpha wins. For example, an existing 5-year BBB bond from a company yields 5%. That company issues a new 5-year BBB bond at a modest yield premium (yielding 5.1%) to get the issue away. Soon after issuance, the yield converges to 5% (c.2% capital appreciation) which the active manager can harvest and reinvest into new opportunities.
One that Stephen Snowden at Artemis likes to exploit is cross-currency issuance opportunities. Global companies issue bonds in multiple currencies, and there are often opportunities to harvest additional return by buying a bond of the same duration and credit risk but issued in a foreign currency and hedged back to sterling.
Another area active managers can and do excel in is less well known, or less well understood fixed income markets such as asset backed debt, private credit, and emerging market debt. Often there is an additional return pick up for ‘complexity’ from these areas where active managers can get a significant edge.
There is still a lot of value in the asset class, you’ve just got to do a lot more digging today than a couple of years ago when spreads were wide. We also recognise the opportunity sovereign bonds present today is compelling in absolute and relative terms and have been increasing our exposure here. Indeed, our funds have the highest exposure to gilts we can recall, for the yield they offer but also the likely diversification from equities now offered compared to the past.
JPM CEO Jamie Dimon hit the news recently with a ‘cockroach’ analogy warning of potential hidden risks in the financial system following the bankruptcies of private credit companies First Brands and Tricolor Holdings stating that, “When you see one cockroach, there are probably more.”
When it comes to pest control, and bond investment, our view is that an active approach to the problem makes sense. Active management in fixed income has the benefit of enhancing potential returns by taking advantage of the wealth of inefficiencies across fixed income markets and avoiding some of the worst areas of the asset class via robust credit analysis.
Dan Cartridge – Fund Manager
For professional advisers only. This article is issued by Hawksmoor Fund Managers which is a trading name of Hawksmoor Investment Management (“Hawksmoor”). Hawksmoor is authorised and regulated by the Financial Conduct Authority. Hawksmoor’s registered office is 2nd Floor Stratus House, Emperor Way, Exeter Business Park, Exeter, Devon EX1 3QS. Company Number: 6307442. This document does not constitute an offer or invitation to any person, nor should its content be interpreted as investment or tax advice for which you should consult your financial adviser and/or accountant. The information and opinions it contains have been compiled or arrived at from sources believed to be reliable at the time and are given in good faith, but no representation is made as to their accuracy, completeness or correctness. Any opinion expressed in this document, whether in general or both on the performance of individual securities and in a wider economic context, represents the views of Hawksmoor at the time of preparation and may be subject to change. Past performance is not a guide to future performance. The value of an investment and any income from it can fall as well as rise as a result of market and currency fluctuations. You may not get back the amount you originally invested. FPC25593.
