Credit Markets:
- Investment-Grade (IG) Corporates: IG corporate bonds provided attractive yields, though they only slightly outperformed Treasuries during the first half of 2025.1 Fundamentals for IG issuers are generally stable, but their spreads are low, providing a limited buffer in case of economic slowing.
- High-Yield Bonds and Leveraged Loans: These assets demonstrated resilience despite trading at compressed spreads. Defaults remained low by historical standards, though modest increases are projected for 2026. Floating-rate assets, including bank loans and CLOs, offered relative value during the quarter.
Securitized Markets:
- Residential Mortgage-Backed Securities (RMBS)/Commercial Mortgage-Backed Securities (CMBS): The securitized fixed income landscape exhibited sector-specific dynamics throughout Q2. RMBS demonstrated notable resilience, with seasoned and higher-quality deals leading performance. The CMBS market showed bifurcated results—office sector challenges persisted with elevated delinquencies and special servicing transfers, while multifamily and industrial properties maintained stability. Lodging sector cash flows began showing early signs of softening.
- Asset Backed Securities (ABS): The ABS sectors, including auto leases and credit cards, exhibited resilience, while subprime auto and private student loans experienced higher delinquencies within historical ranges. The ABS market absorbed significant new issuance with minimal spread widening, indicating robust investor demand.
- Collateralized Loan Obligations (CLOs): CLOs outperformed other securitized sectors, with AAA-rated tranches demonstrating particular resilience. However, lower-rated tranches, especially CCC-rated securities, faced pressure from increased loan defaults and distressed exchanges, with the loan default rate reaching 3.9% by quarter-end.1
Strategic Positioning for H2 2025
Given the current market environment, our strategic positioning emphasizes four key pillars:
Quality Focus: Economic uncertainties warrant prioritizing high-quality segments, particularly investment-grade corporates and structured products with strong credit ratings. Robust fundamentals remain intact, but heightened trade uncertainty and sector-specific challenges support a more defensive approach.
Duration and Curve Management: With the Federal Reserve maintaining a cautious stance on rate cuts, active duration risk management is essential. Shorter-duration securities may provide protection against potential interest rate volatility, while curve steepening strategies likely offer superior risk-reward profiles compared to directional duration plays
Selective Diversification: Balanced diversification across asset classes and geographies helps mitigate sector-specific and regional risks while capitalizing on targeted opportunities. In the current environment, this means diversifying within credit by balancing high-quality corporate bonds with floating-rate assets like ABS, leveraged loans, and CLOs. Within securitized products, focus on resilient ABS like auto leases and credit cards, and in CMBS, maintain exposure to stable property types such as multifamily and industrial while avoiding the challenged office sector.
Active Security Selection: Given tight valuations, security selection is crucial for enhancing risk-adjusted returns. With credit spreads at cycle lows, the focus should be on issuers with robust fundamentals that offer a buffer against potential economic slowing. In CMBS, this means emphasizing high-quality, well-located assets while avoiding exposure to transitional or lower-quality office properties facing elevated delinquencies. For CLOs, it is prudent to concentrate on higher-rated tranches to mitigate the credit risk from an increase in loan defaults and distressed exchanges. A potential slowdown in new ABS issuance could also support valuations, making careful selection within that sector critical.
The fixed income markets present a nuanced opportunity set for the remainder of 2025, balancing attractive yields against compressed valuations Success will depend on maintaining vigilance around quality, managing duration risk effectively, and staying informed about economic and geopolitical developments that could impact market dynamics The current environment rewards disciplined security selection and strategic positioning over broad market exposure.
IMPORTANT DISCLOSURE
Availability of products and services provided by MacKay Shields may be limited by applicable laws and regulations in certain jurisdictions and this document is provided only for persons to whom this document and the products and services of MacKay Shields may otherwise lawfully be issued or made available. None of the products and services provided by MacKay Shields are offered to any person in any jurisdiction where such offering would be contrary to local law or regulation. This document is provided for information purposes only. It does not constitute investment advice and should not be construed as an offer to buy securities. The contents of this document have not been reviewed by any regulatory authority in any jurisdiction. All investments contain risks and may lose value and these materials do not undertake to explain all of the risks associated with any investment strategy referred to herein. Clients and investors should not invest in any strategy referred to herein unless satisfied that they and/or their representatives have requested and received all information that would enable them to evaluate the merits and risks thereof. Any forward looking statements speak only as of the date they are made, and MacKay Shields assumes no duty and does not undertake to update forward looking statements. Any opinions expressed are the views and opinions of certain investment professionals at MacKay Shields which are subject to change without notice. There may have been, and may in the future be, changes to the investment personnel responsible for the management of the strategy(ies) described herein, as well as changes to the investment process utilized by such investment personnel. Past performance is not indicative of future results.
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The information in these materials is not an offer to sell securities or a solicitation of an offer to buy securities in any jurisdiction of Canada. In Canada, any offer or sale of securities or the provision of any advisory or investment fund manager services will be made only in accordance with applicable Canadian securities laws. More specifically, any offer or sale of securities will be made in accordance with applicable exemptions to dealer and investment fund manager registration requirements, as well as under an exemption from the requirement to file a prospectus, and any advice given on securities will be made in reliance on applicable exemptions to adviser registration requirements.
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