The sweet spot, or in more colloquial terms, refers to when a baseball player hits the ball squarely; it is said that they have made contact with the sweet spot of the bat on the baseball.
Roughly 5"–7" from the end of the barrel near the bat's center of mass, the sweet spot is the area of the bat where vibrations are minimal, and energy transfer is at its best, producing powerful and accurate hits.
Just as sluggers aim to make contact at the sweet spot of the bat for maximum impact, investors, too, can identify a similar sweet spot in the crossover segment between "BBB" and "BB" bonds, where the potential for appealing risk-adjusted returns is at its peak.
Crossover credit: The sweet spot
Compared to equities and cash, increased yields and attractive valuations support the outlook for fixed income.
We believe the crossover credit segment is one of the most promising strategies for income-oriented investors.
Within the fixed income sector, we believe the crossover credit segment is one of the most promising strategies for income-oriented investors.
These are bonds that straddle the line between the lowest investment-grade (IG) rating (BBB) and the highest high-yield rating (BB). History tells us that a combination of these bonds can provide the best risk-adjusted outcomes – making it the sweet spot of credit. While always remembering, of course, that the past shouldn't be treated as a guarantee of future performance.
Fixed income more attractive for income investors
After languishing for several years, interest rates and yields have returned to normal levels, enhancing the attractiveness of fixed-income assets. Credit spreads are a little on the rich side, but this is where increased bond yields can provide a valuable cushion against potential downside risks.
Furthermore, we believe corporate bonds currently offer good value compared to equities and cash. For example, the current global IG index yield of 4.5% is significantly higher than the S&P 500 earnings yield of 3.4% and the 4.3% yield available from cash.1,2,3
Focusing on the credit sweet spot
We see particular merit in focusing on “BBB” and “BB” corporate bonds in their entirety. This sweet spot has delivered some of the best risk-adjusted returns in credit markets.
Over the past 25 years, a 50/50 allocation to BBB-rated global IG bonds and BB-rated global high-yield bonds delivered returns similar to global high-yield bonds (Chart 1).
Chart 1. A 50/50 allocation gives high yield-like returns …*
Source: ICE BofA indices, based on monthly US dollar hedged index returns for the 25 years to end-2024. *Note: 50/50 allocation refers to a 50% allocation to BBB bonds, coupled with a 50% allocation to BB bonds.
But with risk levels closer to global IG bonds (Chart 2).
Chart 2. … But with much lower risk
Source: ICE BofA indices, based on monthly US dollar hedged index returns for the 25 years to end-2024.
Currently, a 50/50 allocation would provide a US-dollar hedged yield of around 5.8%, which compares favorably to the US-dollar cash yield of 4.3%.3
What explains the sweet spot of credit?
In short, structural inefficiencies. The demarcation between IG and high-yield corporate bond markets is somewhat artificial and arbitrary. Around this borderline, inefficiencies often occur, and corporate bonds are sometimes incorrectly categorized in relation to their evolving fundamentals.
Yield generation and excess return potential
We believe this credit sweet spot should also appeal to active investors due to the potential for mispricing at the individual security level. The sheer size and diversity of the opportunity set – with over 2,300 issuers across US, Pan-European, Asian, and emerging markets – support the opportunities for yield generation and excess returns.
The sweet spot also encompasses subordinated financial and non-financial subordinated bonds (e.g., corporate hybrid debt), which can provide significant tactical value at different points of the economic cycle.
Active bond investors who can spot mispricing and/or predict rating transitions can potentially earn a significant additional return premium.
The home of rising stars and fallen angels
And then there are rising stars and fallen angels. The former are bonds of companies currently rated high yield but whose credit fundamentals are progressing toward the IG level. The latter are bonds rated as IG that have fallen into the BB (high yield) category. Both contribute to the strong risk-adjusted outperformance of the BB-ratings category.
For fallen angels, the initial adverse market reaction to the downgrade might be excessive, creating a buying opportunity. Additionally, issuing companies are incentivized to reduce financing costs by reclassifying themselves as IG. This can lead to debt restructurings or operational improvements that enhance the company’s performance.
Meanwhile, rising stars retain their high yield as their credit financial health improves, offering better risk-adjusted returns. The market also often reacts positively to subsequent credit upgrades.
Final thoughts
Higher yields have bolstered the attractiveness of fixed income. Within corporate credit, we favor the crossover segment by combining “BBB” and “BB” bonds in their entirety. We believe a careful, active approach within this large and diverse opportunity set can potentially deliver income and returns closer to those of high-yield investments but with risk similar to IG investments. This is why we believe it’s time for investors to step up to the plate and consider investing in the sweet spot of credit.
1 Bloomberg for IG bonds (Bloomberg Global Aggregate Index), February 2025.
2 "S&P 500 Earnings Yield." Economic Indicators. GuruFocus, February 2025. https://www.gurufocus.com/economic_indicators/151/sp-500-earnings-yield.
3 US Money Market Treasury Yield, February 2025.
Important information
Projections are offered as opinion and are not reflective of potential performance. Projections are not guaranteed and actual events or results may differ materially.
Foreign securities are more volatile, harder to price and less liquid than U.S. securities. They are subject to different accounting and regulatory standards, and political and economic risks. These risks are enhanced in emerging markets countries.
Fixed income securities are subject to certain risks including, but not limited to: interest rate (changes in interest rates may cause a decline in the market value of an investment), credit (changes in the financial condition of the issuer, borrower, counterparty, or underlying collateral), prepayment (debt issuers may repay or refinance their loans or obligations earlier than anticipated), call (some bonds allow the issuer to call a bond for redemption before it matures), and extension (principal repayments may not occur as quickly as anticipated, causing the expected maturity of a security to increase).
Standard & Poor’s credit ratings are expressed as letter grades that range from “AAA” to “D” to communicate the agency’s opinion of relative level of credit risk. Ratings from ‘AA’ to ‘CCC’ may be modified by the addition of a plus (+) or minus (-) sign to show relative standing within the major rating categories. The investment grade category is a rating from AAA to BBB-.
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