Corporate debt: Investment grade and high yield
We have a moderately constructive outlook overall. We anticipate periods of volatility across all risk markets as we approach the U.S. elections. Reflecting investor demand for risk, investment-grade corporate bonds outpaced the broad investment-grade fixed-income market but trailed high-yield corporate credit during the quarter. Accordingly, more defensive areas of the market lagged, including U.S. government securities and agency mortgage-backed bonds. Credit spreads tightened during the three months. Our corporate credit holdings — primarily high-yield bonds and convertible securities — added the most value this quarter. Emerging-market [EM] debt also performed well, but gained only about half as much as high-yield credit, in U.S.-dollar terms, during the three-month period.
We have a relatively positive medium-term outlook for corporate credit. While there are risks, there are factors that will be supportive of the U.S. corporate credit market. These include demand for comparatively higher yields in the face of much lower yields globally. Investors know the Fed stands ready to provide further support to the market via its bond purchase facilities if necessary. That has provided an important boost to market sentiment. The central bank has so far invested only a small portion of the $750 billion earmarked for corporate debt purchases. Also, even though high-yield spreads retightened following their sizable widening in March, we think valuations remain relatively attractive.
In high-yield credit, we are closely watching sectors vulnerable to the disruption caused by the pandemic, including energy, gaming, lodging & leisure, and retail. Within these groups, we are focusing on the health of issuers' balance sheets and liquidity metrics, as well as the risk of defaults or credit-rating downgrades.
Trends in the mortgage market
COVID-19 created significant headwinds for the CMBS market due to the negative impact on commercial real estate. That said, during the quarter, we began to see some improvement in higher-rated cash bonds. We continue to have conviction in our CMBX positions, which we believe fairly compensate investors for current risk levels. (CMBX is an index that references a basket of CMBS issued in a particular year.)
Within residential mortgage credit, we believe the agency credit-risk transfer securities (CRT) sector directly benefits from the efforts of the government and government-sponsored enterprises such as Fannie Mae and Freddie Mac to keep people in their homes. We also believe the dislocations that occurred in March were mitigated by U.S. monetary and fiscal policy and the gradual reopening of the economy. As a result, we continue to find value in various segments of the CRT market, as well as the non-agency residential mortgage-backed market.
We are also continuing to find value in prepayment-sensitive areas of the market despite a recent increase in refinancing activity. Agency interest-only (IO) and inverse interest-only securities in the collateralized mortgage obligation (CMO) space continue to be our focus, particularly securities with lower coupons and more seasoned collateral, as well as reverse mortgages and those with jumbo loan balances.