Finding income in the crossover credit sweet spot

In fixed income, investors are used to making trade-offs. Higher yield usually means higher volatility, weaker balance sheets and a greater chance of default. Lower-risk bonds, meanwhile, often come with modest income – especially in periods of economic uncertainty.

But the picture is more nuanced as the relationship between credit ratings and risk isn’t a simple one. Instead, there's a distinct part of the market where the income boost is meaningful, yet the additional risk is far more modest than many assume. That area is crossover credit – the space where the lowest tier of investment-grade (IG) debt (BBB) meets the highest tier of high yield (HY) (BB).

It’s a corner of fixed income that has quietly delivered some of the strongest risk-adjusted returns over the past quarter century. A balanced mix of BBB and BB bonds has historically produced returns close to broader HY, but with volatility and long-term default behavior much closer to investment grade.

In today’s uncertain environment – with investors looking for clarity on rate cuts, geopolitical surprises and fragile sentiment – that combination of income and resilience is particularly attractive.

Understanding the sweet spot

Crossover credit sits at a fascinating junction in global bond markets. As credit ratings decline, yields do rise, but the increase in risk is far from linear.

Defaults and severe drawdowns are typically concentrated among lower-quality single-B and CCC issuers. BBB and BB companies, by contrast, tend to be larger, more established and better capitalized. They also have superior access to funding and a proven ability to manage their businesses through economic cycles.

That’s why stepping from A-rated bonds into BBB often delivers a noticeable income lift with only a small rise in underlying risk. Moving from BBB into BB enhances yield again - but still avoids the steep jump in default risk that appears further down the quality spectrum (Chart 1).

In other words, investors can capture a substantial slice of additional yield before they reach the risk-heavy end of HY credit.

A broad and expanding opportunity set

One of the least appreciated features of this crossover segment is its scale. Over the past two decades, the BBB and BB universes have grown markedly as companies have matured, deleveraged or migrated between rating buckets (Chart 2).

Today, this area of the market encompasses more than 2,300 issuers across the US, Europe, Asia, and emerging markets. That’s a deep and diverse hunting ground for income-focused investors.

Importantly, the universe also includes specialized instruments such as subordinated financial bonds and corporate hybrids. These structures can offer compelling yield opportunities at different points of the economic cycle.

For active managers, this breadth supports consistent opportunities to identify mispriced bonds, capture relative-value dislocations, and position for rating changes.

Fallen angels, rising stars …

Two types of issuers play a key role in the outperformance of the crossover category.

Fallen angels

Fallen angels, or companies downgraded from investment grade into BB, often face forced selling by investors restricted to investment grade. This mechanical pressure can push prices down more than fundamentals justify. For patient investors, that can create attractive entry points. In addition, many issuers act quickly to regain investment grade status - through cost discipline, asset sales or refinancing - which can further support a bond’s recovery.

Rising stars

Rising stars often travel the other way. They start life in HY but move toward investment grade as their balance sheets and business performance strengthen. These bonds often reprice positively as upgrades approach, rewarding investors who can spot the transition early.

… and why they matter

Together, fallen angels and rising stars reinforce a key advantage of the crossover segment: long-term structural inefficiencies that routinely create opportunities for active credit research.

Why crossover credit stands out today

Periods of market anxiety have historically highlighted the value of resilient income. Today is no different. With central banks balancing inflation risks against softer growth signals, investors are again reassessing where to find stable return streams without taking excessive risk.

Crossover credit stands out for three reasons:

Important information

Projections are offered as opinion and are not reflective of potential performance. Projections are not guaranteed and actual events or results may differ materially.
Foreign securities are more volatile, harder to price and less liquid than U.S. securities. They are subject to different accounting and regulatory standards, and political and economic risks. These risks are enhanced in emerging markets countries.
Fixed income securities are subject to certain risks including, but not limited to: interest rate (changes in interest rates may cause a decline in the market value of an investment), credit (changes in the financial condition of the issuer, borrower, counterparty, or underlying collateral), prepayment (debt issuers may repay or refinance their loans or obligations earlier than anticipated), call (some bonds allow the issuer to call a bond for redemption before it matures), and extension (principal repayments may not occur as quickly as anticipated, causing the expected maturity of a security to increase).
Standard & Poor’s credit ratings are expressed as letter grades that range from “AAA” to “D” to communicate the agency’s opinion of relative level of credit risk. Ratings from ‘AA’ to ‘CCC’ may be modified by the addition of a plus (+) or minus (-) sign to show relative standing within the major rating categories. The investment grade category is a rating from AAA to BBB-.

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