A simple but effective rule for fixed income is to avoid taking uncompensated risk. Investors should only allocate to risky bonds (corporate, junk, etc.) when the yield spread over risk-free T-bills is above its historical average. When spreads are tight or inverted, holding T-bills provides a better risk-adjusted return.

Unlike in past cycles, the riskiest underwriting has largely occurred in leveraged loans and private credit, not high-yield bonds. This migration has left the public high-yield market with higher-quality issuers and shorter durations, making it more resilient than its reputation suggests.

While strong demand has compressed risk premiums to historic lows across most fixed income markets, debt backed by commercial mortgages (CMBS) is a notable exception. CMBS spreads are significantly higher than their long-run average, presenting a rare value opportunity for credit investors in a market where yield is scarce.

Post-crisis stigma has faded, making Collateralized Loan Obligation (CLO) tranches a top relative value pick in credit markets. The structure allows investors to precisely select risk exposure, from safe AAA tranches with attractive spreads to high-return equity positions, outperforming other credit assets.

While corporate bond yields seem attractive, this is almost entirely due to high government rates. The actual credit spread—the premium investors receive for taking default risk—is at a multi-decade low. Investors are being poorly compensated for the risk they are taking on corporate balance sheets.

While mortgage-backed securities (MBS) have rallied and are at five-year tights, the trade is not over. Investment-grade corporate bonds are at 20-year tights, making MBS still look cheap on a relative value basis. The strategy now is to tweak the trade rather than abandon it entirely.

In a market where everyone is chasing the same high-quality corporate bonds, driving premiums up, a defensive strategy is to pivot to Treasuries. They can offer comparable yields without the inflated premium or credit risk, providing a safe haven while waiting for better entry points in credit markets.

With spreads as a percentage of yield at a 25-year low of 15%, investors' returns are dominated by movements in government bond rates, not the premium for taking corporate default risk. This is a hidden vulnerability masked by high all-in yields.

Due to tight credit spreads, Richard Bernstein Advisors (RBA) has taken the unusual step of eliminating all corporate credit exposure from its portfolios. They favor agency mortgage-backed securities, which currently offer a similar or better yield without the associated corporate downgrade or default risk.