The first quarter was by no measure a good time to own bonds. As measured by the broadest Barclays index, global fixed income lost 6.1%, with sovereign debt marginally worse on a 6.2% fall.

Going back further to the beginning of the current slide in US Treasuries in July last year, the world’s biggest and most liquid store of value is down 16%, according to analysis by US fund house Verdad, the fifth greatest drawdown in the market ever. Nor has the new quarter offered much relief.

The inversion of the US Treasury yield curve in early April — as the price of two-year bonds fell below that of the 10-year — is one of the biggest and most bulletproof recession indicators out there, with a 50-year track record of positive forecasts.

The gloom is not uniform however, and some unexpected areas of the market have proven more effective than others in fulfilling bonds’ historical role of downside protection. In particular, US high yield has actually performed better than investment grade.

US high yield v US high quality

Source: BoAML, Fred

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So could additional credit ‘risk’ actually help keep your fixed income allocation above water?

While the direction of travel may not easily fit into a classical macro model, Artemis head of fixed income Stephen Snowden noted that, given the dislocation between credit and rate cycles, the relative outperformance of lower-rated debt may make intuitive sense.

According to credit rating agency Fitch, the US corporate default rate sits at a record low, on a 20-year time series. While issuance last year was high at $622bn (£489bn), the supply of new credit is forecast to fall almost 28% this year, according to Moody’s.

Given the lower end of the market is driven more by credit than rates, the recent tightening has weighed more heavily on those with higher correlations with sovereigns.

‘[We’ve] seen rapid balance sheet deleveraging,’ noted Snowden. ‘Since the Covid spike (in operational debt levels), on average, you’ve seen interest coverage reach very comfortable levels. And you've seen margins improve.

‘For the developed markets, when you look, there’s basically no level of distress. So that is a real reminder that on the ground, in a lot of the developed credit markets, the fundamentals are pretty strong.’

Snowden noted that selectivity remained key, however. According to Bank of America Merrill Lynch data, the rally in high yield which has occurred as markets recovered their poise following the worst of the February/March sell-off has been driven by more defensive issues, with a significant spread of returns across the market.

Telecoms, tech and healthcare had returned 2.7%, 1.7% and 1.4% in price terms respectively in recent weeks, wrote Bank of America Merrill Lynch chief investment strategist Michael Hartnett, while at the other end of the scale real estate was 0.1% lower and materials 0.3%.

‘The ability for more vulnerable credits to absorb wage inflation and input cost pressure, there is an element of buffer there,’ Snowden added. ‘Actual stock selection will be key… it will be increasingly important to not have a lazy index exposure, it needs to be stock selection, and it needs to be an active approach.’

Hartnett observed that some of the upward strength of selective high yield bonds may be due to a ‘dash for trash’ from the Q1 lows however, rather than a durable source of return.

George Curtis, multi-sector bond manager at TwentyFour Asset Management, agreed that demand had been the overwhelming short-term driver, with a moderate return of risk appetite coinciding with weaker than usual issuance.

He added that he expected high yield to continue to have value as a hedge however, during a period when both central bankers and sovereign investors were struggling with an historic reversal of inflation.

He similarly echoed Snowden’s view on the importance of security selection, although he added that keeping duration on a tight leash was equally critical.

‘While we do not view current spread levels as expensive, we do not regard them as cheap,’ he said. ‘Therefore, in recent months, we have focused our efforts on trading up in quality, positioning at the short end of credit curves and buying those names we believe possess strong pricing power, enabling them to perform in an inflationary environment.’