Corporate debt: Investment grade and high yieldLooking first at corporate credit, we have a positive outlook for the fundamentals and overall supply-and-demand backdrop of high-yield bonds. Our view on valuation is more neutral, however, given the relative tightness of yield spreads as of quarter-end. Within the high-yield market, we are continuing to closely monitor issuers' balance sheets and liquidity metrics, with an eye toward default risk or a credit-rating downgrade.
Relative to other asset classes, high-yield bonds outperformed the broad investment-grade fixed-income market and investment-grade corporate credit, but slightly lagged high-yield bank loans. We have a positive outlook for high-yield market fundamentals and the overall supply-and-demand backdrop. Our view on valuation is more neutral, given the relative tightness of yield spreads in the market as of quarter-end. Our optimism is driven by the sizable percentage of Americans who have received Covid-19 vaccines, along with continued government stimulus. We were encouraged that, as of September 30, U.S. cases of, and hospitalizations from, Covid continued to steadily decline. Within this environment, we remain focused on the health of issuers' balance sheets and liquidity metrics, with an eye toward default risk or a credit-rating downgrade. Concerns about defaults have meaningfully retreated this year, given the liquidity in the market. In our view, many troubled issuers have been given the lifeline they need to continue operating.
Trends in the mortgage marketsIn the commercial mortgage-backed securities market, we believe there are attractive risk-adjusted investment opportunities available amid an improving fundamental backdrop. We continue to find value among issues that have been on the market for a few years. At the same time, we are also investing in newer issues backed by relatively long leases and what we consider to be strong underwriting.
Within residential mortgage credit, given low mortgage rates, high demand, and a declining inventory of available homes, we think home prices are likely to continue rising.
In Q3, risk assets generally posted weaker excess returns as a number of concerns crept into the market Excess returns* relative to Treasuries, Q3 2021 Source: Bloomberg, as of 9/30/21. Indexes are unmanaged and do not incur expenses. You cannot invest directly in an index. Past performance is not indicative of future results. Click here for index definitions.
* Excess returns are calculated relative to comparable maturity U.S. Treasuries for each index. Excess return does not always mean "outperformance."
In Q3, risk assets generally posted weaker excess returns as a number of concerns crept into the market
Excess returns* relative to Treasuries, Q3 2021
Source: Bloomberg, as of 9/30/21. Indexes are unmanaged and do not incur expenses. You cannot invest directly in an index. Past performance is not indicative of future results. Click here for index definitions.
Given that prices have already risen substantially, we are aware that affordability has become a constraint for many prospective buyers. Against this backdrop, even with tighter yield spreads, we are finding value in investment-grade securities backed by non-agency residential loans. We also see value in legacy residential mortgage-backed securities and lower-quality segments of the agency credit-risk transfer market.
We believe prepayment-sensitive areas of the market serve as important sources of diversification. In our view, interest-only collateralized mortgage obligations (IO CMOs) and other types of prepayment-related securities offer attractive risk-adjusted return potential at current price levels if refinancing activity recedes and mortgage prepayment speeds slow.
In emerging markets, we are seeking opportunities in countries we think are better positioned to benefit from a global recovery and are less exposed to domestic policy risks.
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More from Fixed Income Outlook
Fixed-income markets faced multiple risks, including the Fed's plan to unwind debt purchases, the shifting growth outlook, and Covid-19. But, we believe the environment for bonds remains supportive.