When Credit Spreads Are Tight, Quality Matters More Than Yield

GMO argues that historically tight investment-grade credit spreads leave investors exposed to asymmetric downside risk, making a shift toward higher-quality carry strategies increasingly attractive.

• With spreads below 85 basis points, historical analysis suggests a high probability of spread widening over the next year, limiting potential upside.

• Structured credit strategies with shorter spread duration can offer higher carry while reducing mark-to-market sensitivity during volatility.

• Prioritizing senior positions in the capital structure and avoiding negatively convex securities can improve risk-adjusted returns through credit cycles.

When valuations leave little margin for error, the key question becomes clear: are investors being adequately compensated for the credit risk they are taking?