Capital Ideas^™ 
Investment insights from Capital Group

The current macroeconomic environment has created a supportive backdrop for multi-sector credit, with yields likely to remain elevated as inflation lingers above central bank targets. This market provides a good opportunity for credit investors to generate attractive returns by allocating strategically across a diversified mix of sectors.

Here are five factors we believe will support multi-sector portfolios in 2025:

1. Positive economic growth provides a strong backdrop for credit

Uncertainty around policy outcomes related to tariffs, tax, regulation and foreign relations are unusually high, but the data and information we have suggests we should continue to expect positive growth and slowly falling inflation. U.S. corporate earnings growth is projected to be 14.8% year-over-year.

Additionally, investment-grade (BBB/Baa and above) and high-yield issuer balance sheets are in good shape for this part of the economic cycle, creating strong fundamental support for the asset classes. Capital requirements for refinancing are low and the outlook for defaults remains subdued.

For high yield specifically, the impact of sticky but decelerating cost inflation may create an environment of lower revenue and earnings growth. But earnings remain positive, and the high coupons available in this market still look attractive. Importantly, high-yield issuers generally do not need significant earnings growth to service existing debt obligations or generate cash flow. 

2. Volatility highlights the need for a flexible approach

Rate and spread volatility could be elevated in 2025, as markets price in shifting expectations around economic growth, political instability and potential Federal Reserve action. Spreads to Treasuries and interest rates should remain range-bound, with yields on 10-year Treasuries hovering between 4% and 5% and spreads staying near the tight end of historical valuations. Still, there could be opportunities within those ranges by rotating across credit sectors, especially if spread volatility increases and high-yield bonds underperform higher quality investment-grade (IG) assets.

Uncertainty around Federal Reserve decisions and monetary policy changes could trigger volatility and create opportunities within more rate-sensitive sectors like IG, which has more than double the duration of high yield.  

3. Credit selector’s market 

Credit spreads have broadly recovered from the wide levels of the last several years, and some sectors are at or near their tightest level in recent history. Critically, credit markets are fragmented and diverse, meaning there is no measure of valuations that can describe the entire market as “rich” or “cheap.” By shifting allocations when opportunities arise, investors in multi-sector income strategies can seek to capture value in credit markets wherever it exists.

Thematically, in applicable multi-sector income portfolios, we are looking to allocate to issuers in industries where there are potential catalysts for spread tightening. These include cost reductions, debt paydown, underlying asset valuation recovery, event risk mitigation and improved refinancing opportunities. For example, in commercial real estate, we see a continued recovery in underlying asset value, driven by an easier financing environment and improving occupancy.

When spreads are largely narrow, issuer selection is key. In certain sectors, including pharmaceuticals, utilities, managed health care, energy and commercial real estate, fundamental analysis reveals opportunities where individual names trade at wider spreads than the broader market, and/or wide of fair value. Within the pharmaceutical sector we see numerous opportunities. Some issuers are paying down debt and are likely to be upgraded by rating agencies. In other sectors, we expect spreads to tighten where companies have successfully offset the risk of patent expirations by launching new products.

4. An increase in M&A-related issuance may provide opportunities

We expect a friendlier regulatory environment from the new U.S. administration, which may lead to an increase in mergers and acquisitions (M&A). This should present opportunities. M&A-related bonds are typically issued at a premium to existing bonds in the market and often tighten over time as synergies are realized and companies pay down debt.

This trend has been observed over the past several years, especially in the pharmaceutical sector, where companies have frequently issued debt to fund acquisitions. Over time, higher cash flows have allowed these issuers to pay down their debts, which has been a catalyst for spread tightening.

We expect M&A to increase in areas of the health care sector. Some senior executives have signaled they expect increased deal volume in 2025. The growing number of mature companies sitting in the private equity market could also contribute to increased M&A activity across sectors. Valuations, M&A track records and engagement with sellers will be key indicators of where we may find opportunities and value.

5. Securitized valuations remain compelling

Securitized credit remains attractive on both an absolute and relative basis. Spreads across several areas remain wide as concerns around both consumer and commercial real estate weigh on the sector. But we are being opportunistic. Our asset-backed securities (ABS) and commercial mortgage-backed securities (CMBS) analysts believe these worries are ‘throwing the baby out with the bath water.’ Our analysts have identified opportunities to invest in select well-capitalized securitized tranches, where they expect valuations will revert to historical norms compared to IG corporates.

For instance, we are selectively finding value in office properties, including single-asset single-borrower (SASB) deals as well as conduit CMBS, as return-to-office mandates boost occupancy and the refinancing environment improves. AA and single A rated tranches are well-capitalized and offer credit spreads well above comparable IG corporate credit.