Tighter credit spreads, same underwriting discipline – 2nd quarter, 2026

Enjoyed what you read below and want to hear directly from the author? Investment Team member Tracey Chen talks about her Q2 2026 commentary with relationship manager Sydney Campbell. They discuss the importance of having a consistent credit process regardless of market conditions.

People outside of credit investing often view credit spreads as an economic barometer. When spreads are as narrow as they are today, people take comfort in the belief that there’s little risk in the market because default rates are low and refinancing is readily available. But for a fixed income manager, you’re often standing at a crossroads:

1. Keep your underwriting standards unchanged, regardless of spreads

2. Reach for yield by moving down the quality spectrum.

Choosing the first option can be painful. As spreads shrink, so do your opportunity set, portfolio yield and future return potential if nothing else changes. This is especially difficult when the market continues to reward investors for reaching for yield as spreads grind tighter. Yet by maintaining the same underwriting standards, you preserve the credit quality of your portfolio and the flexibility to act when the environment changes.

The second option is tempting. Reaching for yield can generate higher returns when the economy looks healthy, corporate balance sheets appear strong and nothing seems to be going wrong. The question those bond managers might be unprepared to answer is whether those credit portfolios are sturdy enough to handle an inevitable credit market shift.

Longtime investors in EdgePoint credit won’t be surprised that we’ve chosen the first path. That’s not to say there aren’t any opportunities – there are always pockets of volatility that we’re taking advantage of. We continue to find overlooked securities that we believe offer attractive yields without compromising our underwriting standards. Despite index spreads grinding steadily tighter, the average credit rating of the bonds held in EdgePoint credit portfolios has remained remarkably consistent:

While ratings aren’t how we assess a business’ creditworthiness, they’re useful for illustrative purposes. This raises the question – how do we know we’re being disciplined rather than simply stubborn?

The truth is that there isn’t a real-time scoreboard. After more than three years of tightening credit spreads, patience rarely looks intelligent. In fact, it often seems like a mistake. Portfolios that reach for yield by moving down the capital structure, investing in lower-quality issuers or accepting weaker covenant protection have generally outperformed in the short term. By contrast, portfolios that maintain consistent underwriting standards can appear to be leaving returns on the table because they deliberately pass on opportunities that don’t adequately compensate for the risks involved.

The Canadian new issue market provides a good example of how we stick to our investment approach. Since the beginning of 2023, there have been 717 new issues, yet EdgePoint participated in only 32 of them:

While our fixed income returns have remained competitive even in this environment, the real difference between these two approaches is rarely evident during calm periods. It’s often revealed when market conditions change – a pattern we’ve witnessed repeatedly over past credit cycles. Although I don’t have a crystal ball to tell you when that change will come, I can tell you that we’re mindful of it while we’re investing today.

The cushion’s getting thinner

In fixed income, spread is the cushion you have for bearing credit risk. For the same credit risk, you always want to be compensated by a wider credit spread. The wider the spread, the more room there is for things to go wrong. As spreads tighten, that margin of safety narrows.

Today, that cushion is becoming increasingly thin. As the charts below show, both U.S. high-yield and investment-grade spreads are trading at decade lows.

High yield & investment grade option-adjusted spreads

Jun. 30, 2016 to Jun. 30, 2026

Source: FactSet Research Systems Inc. As at June 30, 2026. See Important information – Option-adjusted spreads for additional details.

At the same time, the spread premium between high-yield and investment-grade bonds, as well as the premium between broadly syndicated loans and private credit, has also compressed to historically tight levels.

High yield vs. investment grade spread & direct lending vs. broadly syndicated loan yield premium

2016 to 2026

Source, index spread: FactSet Research Systems Inc. Source, yield premium: BofA Global Research, Loan Chartbook June 2006, July 1, 2026. As at June 30, 2026. See Important information – Option-adjusted spreads and Important information – yield premium for additional details.

In other words, investors who put money to work in a way that looks like an index receive progressively less incremental compensation for taking on additional credit risk.

To us, lowering underwriting standards simply because the market offers less compensation is like a mountaineer relaxing their safety checks because the weather’s clear. The mountain hasn’t become any safer, nor have the credit markets. A cycle turn will come, but the time to prepare for it is before it happens. When it arrives, it’s often too late to rebuild your margin of safety again.

This isn’t a macroeconomic forecast – we aren’t suggesting the economy is getting riskier or that businesses have become weaker. Investors today are accepting less compensation for lending to weaker businesses. When spreads are wide, you don’t need perfection to earn attractive returns. But when spreads are tight, you need almost everything to go right. The probability of default may not have changed much, but the consequences of getting the credit wrong have become much greater.

Holding the line

So, how have we maintained our discipline (or what some may still call stubbornness)? It doesn’t simply mean buying higher-rated bonds. It means applying the same underwriting standards and asking the same questions irrespective of spreads.

Thorough credit work is often least appreciated when markets are strong. When refinancing is abundant, defaults are low and spreads continue to tighten, almost every credit investment enjoys a tailwind. In those environments, it’s difficult to distinguish between good underwriting and good luck. But as spreads compress and the cushion becomes thinner, we believe that security selection and rigorous credit analysis can truly shine.

Rather than stretching for yield, we remain focused on what we can control – the quality of the credit. We’d rather generate excess returns by better understanding businesses than by simply taking more credit risk. That means refusing to compromise on the characteristics that ultimately determine whether we get our money back – business quality, cash flow resiliency, asset coverage, structural seniority and covenant protection.

The investments we’ve added to the credit portfolio over the past three years reflect that consistency. While each investment has its own unique story, they share several common characteristics. First, each opportunity was driven by company-specific circumstances rather than broad-market enthusiasm. Second, each offered strong downside protection, whether through business moat, resilient cash flows, valuable asset coverage, disciplined capital allocation, a senior position in the capital structure or structural protections that we believed the market was underappreciating. We didn’t lower our standards to make these investments. We found opportunities that met them. Below are some of the issuers whose debt we’ve purchased over that time:

The kung fu of investing

Those who know me know that I’m an avid tea drinker and my favorite remains Kung Fu Tea. Outside of China, the word “kung fu” is often associated with martial arts. But its original meaning is much broader, referring to the time, patience and discipline required to master a craft. That’s why Kung Fu Tea bears its name – not only because it takes time but because every step is deliberate and unhurried. The quality of the tea comes from consistently applying the same care and attention to detail.

Credit investing is much the same. We can’t control spreads, when markets will reprice risk or when patience will be rewarded. What we can control is the consistency of our process, the quality of our underwriting and the discipline to maintain our standards regardless of market conditions.