Why Now May be the Ideal Time to Hedge Your Credit Market Exposure
As U.S. subprime mortgages started to crack in 2007, then-Citigroup CEO Chuck Prince famously told the Financial Times that, “as long as the music is playing, you’ve got to get up and dance. We’re still dancing.” The credit market’s current exuberance doesn’t match that episode. That said, now, as then, we see rising risks and entrenched investor complacency. The market is close to being priced for perfection and a lot can go wrong. With a nod to the teachings of famed value investor Benjamin Graham, the margin of safety in credit right now is uncomfortably low.
The upshot for advisors? Now may be the time to seek hedges for credit market exposure.
It’s well-known that credit spreads are tight and have been for some time. Yet what exactly does that mean? As the following chart illustrates, at current spread levels, even a reversion to long-term averages could result in material losses for both investment-grade and high-yield bonds—let alone a move toward crisis levels.
Source: Bloomberg L.P. Investment Grade is represented by the ICE BofA US Corporate Index, and High Yield is represented by the ICE BofA US High Yield Index. For illustrative purpose only. % Selloff is calculated using the Bloomberg YAS (Yield and Spread Analysis) function.
Beyond buying protection against a widening of credit spreads, interest rate hedging should also be top of mind for investors, in our view. While central bank rate cuts may provide short-term relief, we see risks to owning duration without a hedge given the structural dynamics at play. Particularly in the U.S., elevated fiscal deficits plus ongoing inflationary pressures may lead to higher long-term rates—even if a recession ensues.
Hedges tend to be cheap when few want them. And when it comes to credit market and interest rate hedges, both are on sale, just as complacency reigns supreme. We suspect there could be a clamour for hedges as 2025 rolls on—at which point investors will likely have to pay up.
The bottom line? Better to seek insurance when premiums are low.
The Picton Mahoney Fortified Income Alternative Fund and Picton Mahoney Fortified Special Situations Alternative Fund are both designed to provide access to hedging tools aimed to mitigate risks commonly associated with income investing, such as interest rate risk, liquidity risk, currency risk and credit risk.
This material has been published by Picton Mahoney Asset Management (“PMAM”) on March 19, 2025.
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