A strategic divergence exists in EM corporate credit. Mandate-bound real money funds feel compelled to stay invested due to a lack of near-term negative catalysts, while more flexible hedge funds are actively taking short positions, betting that historically tight spreads will inevitably widen over the next 6-12 months.

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.

The market for stressed debt (yielding over 10%) has grown 50% to $600B in the last year, while the buyer base is shrinking. This supply-demand imbalance creates a favorable technical setup for specialized investors who can access these assets.

When inflation risk dominates markets, the traditional negative correlation between stocks and bonds breaks down. Bonds (duration) stop acting as a reliable hedge for equity drawdowns. In this environment, investors must seek explicit convexity hedges, like call options on oil or inflation breakevens, rather than relying on a balanced portfolio.

Aggressive liability management exercises (LMEs) are most effective on long-duration debt trading at a discount. As the high-yield market’s average duration has shortened to under three years, the timeframe and opportunity for companies to execute these complex restructurings has become significantly more limited.

With credit curves already steep and the U.S. Treasury curve expected to steepen further, the optimal risk-reward in corporate bonds lies in the 5 to 10-year maturity range. This specific positioning in both U.S. and European markets is key to capturing value from 'carry and roll down' dynamics.

Principal's core strategy is an overweight position in US high-yield bonds. With an average duration below three years and an improved credit quality profile, the sector now functions as a high-carry, short-duration asset, attractive for its risk-reward.

With credit spreads already tight, their potential upside is limited while their downside is significant in a recession scare, offering poor convexity. Goldman Sachs advises that a better late-cycle strategy is to move up the risk curve via equities, which offer more upside potential, rather than through credit investments.

The dominance of leveraged hedge funds as the marginal buyers of long-term bonds means that during a crisis, bonds are sold off alongside equities. This forced de-leveraging negates their traditional safe-haven role, transforming them into a risk asset that falls during market stress.