Hello, Welcome to Credit Edge, a weekly markets podcast.

My name is James Crombie.

I'm a senior editor at Bloomberg.

And I am at Wyner.

I'm a credit analyst here with Bloomberg Intelligence.

This week, we're very pleased to welcome Michael Chang, head of High Yield Corporate Credit at Vanguard, the eleven trillion dollar money manager.

Yes, I said, T not b.

How are you, Michael, I'm doing well good.

Mike's been with Vanguard for close to a decade, with stops at Goldman Winchester, Capitol, and Pimco along the way, and he's the fund manager for Vanguard's bond funds, with the largest fund with assets under manager being the High Yield Corporate Fund, which you can actually find on terminal under the ticker v w e h X.

So with that, do you want to kick us off here, James.

Yeah, We've got loads of questions for you, Michael, but first I just wanted to kind of set the scene a bit.

We are seeing a bit of a risk off move in markets as investors fret over froth in the AI boom and the risk that the Federal Reserve does not cut rates at the December meeting.

There's also a fair amount of anxiety over the economy as inflation stays high and consumers, especially at the low income end, start to buckle.

HI yield bond issuance is coming back, but risky issuers are paying up for access.

In some cases, Applied Digital sold two point three five billion dollars of bonds at one of the steepest discounts of the year as the deals struggled to generate demand.

And in the leveraged loan market there's also issuance, including a notable pickup in deals to pay dividends to private equity owners.

Markets still seem under supplied, though given a lack of m and a So, Michael, what's your take.

Is this a time to lean into risk, take advantage of yields that are still pretty high, grab some year end bargains.

I think that what you just started with, James is there's a lot of stuff going on in the world right now, and a lot of the things that you described I would characterize as kind of the macro environment.

When you think about certainly the AI boom, which has some adjacencies to high yield, although a lot of that is I would argue is stuff going on outside the higher market.

You did reference a deal that is and I AI related deal that did come to market last week.

But the reality is there's a lot of uncertainty right now in the markets.

Certainly there's a lack of data given the government shut down.

There's a lot of uncertainty around things like AI and what types of benefits and you productivity and growth that could come out of that.

And the reality is that uncertainty is being met with relatively tight valuations.

And so when when I look at the market today, and maybe this is specific to high yield, spreads have certainly widened a little bit from the recent tights.

Yields I would say are generally okay, not great, But the reality is where the market is today, it doesn't weave a lot of room for negative surprises and or room for elevated amounts of uncertainty.

And so part of what you've seen more recently, and maybe the specific to the HYO market is a bit of widening just related to more uncertainty, which has related which has translated maybe less in terms of an increase in anticipated defaults, but more just more premium that investors are asking for to delve into some of the riskier parts of the credit markets.

Yeah, Mike, I guess I'll jump in here maybe before we get into the views on the outlook ahead.

I'm interested in hearing your thoughts on kind of how we got to where we are today.

Right, So you just mentioned spread.

So the IG index is at eighty two over the hyolndus is about two hundred and ninety one basis points, both levels that are effectively flat with where we had started the year.

But obviously the path has been extremely volatile in twenty five, right, So in the case of high yield, I think uncertainty certainly breeds opportunity, particularly when events such as you know, Liberation Day takes place where we saw all the pieces on the board of the World Trade you know, game go sort of flying in April, everything got turned on our heads as President Trump wields tariffs to sort of reset the global trade with the United States.

So I'm kind of interested in hearing your thoughts on, you know, what are some of the opportunities that you saw come out of that.

You know, what did you overweight or underweight, whether it be an entire sector or sectors, and sort of which issuers were you guys able to identify some outside returns or maybe even sidesteps some outsized losses.

So there's a there's a bunch of stuff to unpack there, Matt.

So I'll try and take each one on their own.

You reference, current spreads ran around three hundred if you exclude kind of that reached to the kind of very brief peak of spreads that we saw post Liberation Day.

When you look on a twelve month basis, spreads have been somewhat range bound, between two fifty to three point fifty over and so all we're at right now is somewhere in the middle of that range again if you exclude kind of that April cell off where spreads went out to four fifty for a second.

And so you know, when you look top down, things look pretty calm, kind of in the middle of that kind of twelve month range.

I think, as you reference, when you get below the surface is where things start to get a lot more interesting.

And so even in a market where spread has been range bound, part of what we've seen over the past six or twelve months is increasing amounts of dispersion, a lot of disconnects within the market, a lot of differentiation between kind of the haves and have nots.

And so when I look at the market today just at a top level, while valuations aren't that attractive, there have been and continue to be tremendous opportunities to add value.

Actually has an active manager really in terms of picking kind of the right credits to invest in and and maybe just if not more importantly, to avoid the wrong credits to invest in.

You asked about, you know, what are the things that we've been doing over the course of this year to take advantage of kind of the credit markets.

I would say it's definitely been a stock pickers market.

With this version comes opportunity if you are, you know, if you've got the right team in place, if you have the right process to really identify on a proactive basis the right invest right issuers to invest in and the right invest right issuers to avoid.

And so that's really what we've been focused on.

Things like Liberation Day can create some temporary dislocations.

You know, part of the benefit that we have here at Vanguard is just given our structure, given our fee advantage, it does allow us on balance to be a little bit more disciplined, to be a little bit more patient around when and how we take risk.

And so when I think about the beginning of this year, where spreads were tighter than they were today, are about the same.

Our feeling was we weren't really being paid to take risk at a top level, and so we were relatively defensive in our orientation, both from a credit quality point of view as well as staying a little bit closer to home in terms of being a little bit more of a weight some of the more defensive sectors that changed a little bit in April, you know it with some of the kind of broad market sell off, but also the disproportionate impact that we saw on valuation repricing across different sectors.

That kind of brief period really gave us an opportunity to cover some of the underweights in the some of the sectors that we viewed as most sensitive in some cases to things like tariffs, but where we thought valuations had repriced a little bit too much.

And so, you know, those types of opportunities don't come around very often.

You know, you need to be willing and able to take advantage of them when they do appear, and you know, in the case of kind of Liberation Day that that sell off was pretty brief.

You sound a bit cautious, So Michael, and most people that when we have them on the show on the high yield specifically, they sound relatively optimistic, relatively bullish.

You know, balance sheets are in good shape, quality is high, earnings have come in pretty strong, and you know, unless the economy and we're also in you know, an easing cycle.

But unless the economy slips into a recession, and I think no one thinks that the government will allow that to happen, you know that everything will be fine in high yield and you should just lean into risk.

You should buy it.

And you know, I mean it hasn't done particuarly well on the fripple c side, but most of the rest of the market is done.

Okay, What is your caution based on it?

Is it around the economy?

Is it is there something else?

Is it around the cockroach?

Is it something that's just bigger and bigger concern.

I would say fundamentals don't concern us in terms of the health of the high yeal market.

Again, not not to sound like a broken record, I'm sure many of the guests that have come on your show have may have referenced kind of the pretty strong balance sheets in the higher market, the composition of the highal market today, which is quite a bit different than than you know, if you compare it to you know, fifteen years ago, for example, it's it's a much higher quality market that has and should translate into default rate activity that should remain below historical averages.

That's what we've seen over the past couple of years.

That's what we would anticipate, you know, as we think about the next twelve months apps in a recession.

So fundamentals aren't really the issue, you know.

You know, if I think about reasons why we're somewhat cautious on the hio market today, I would I would highlight two things.

One is, and I've already kind of indirectly or directly, you know, talked about evaluations.

Again, valuations are, no matter how you look at it, pretty tight relative to history.

And so as I think about an economic andvironment that is still pretty good, but it's probably on balance getting a little bit weaker.

As I think about monetary policy that is still somewhat uncertain, and a lot of the other kind of headwinds or potential issues that are going on in the macro environment, it's really tough to make a case from a valuation perspective that things are great.

So that's one thing, and then the second thing is in you reference cochroactors, there's just a lot of stuff going on, not necessarily in the highold market, but around the higher market, right, And so as you think about a lot of the headlines that have come out more recently, whether it's on the private credit market, or on the bank own market, or on things like AI, these are things that I would argue are not things that directly impact the higher market.

A lot of the headlines have noticeably not included the higher market, which is kind of interesting because historically people would look at the higher market it as a bit of a canary in the coal mine for future problems that hasn't happened this time around.

I would not anticipate that will be the case this time around.

But this stuff matters, right.

It may not matter insofar as translating into higher anticipated default rates, but when you think about what investors get paid in investing in the HIGHO market, anticipated defaults and credit losses is only part of what you get paid for.

The other part that you get paid for in investing in risk your markets is some form of risk premium, and part of what we've seen over the last couple of years is that risk premium has been pretty compressed, and so I would argue that the big risk to the HYO market isn't so much a big pickup in default rates, but a normalization in that risk premium that investors demand to invest in risk year and in some cases more illiquid parts of the financial markets.

We've been having that conversation for quite a long time, you know, possibly years on this show, and it's become pretty much like gospel for most people that you don't care about the spread, just look at the yield.

I'm surprised but also delighted to hear you mentioned that spread actually matters, because you know, I think it definitely does.

But in terms of like unpacking that there are you know, you just could talk about the fundamentals not being so much of an issue, but again, the technicals are just so strong, So every time there is a set off, every time how it widens out doesn't last very long because it's just so much cash.

So again, you know, you can't really fight the technicals.

I just don't know how you position you know, based on that dynamic.

I would one hundred percent agree.

And you know, just like the old adage don't fight the fad, I think you could easily apply it to what you just said, don't fight the technicals, and we don't.

I think the best course of action.

And you know how we're thinking about managing our portfolios right now is we're not looking to take too much in the way of directional bets the markets, and we never really do.

It's generally a pretty poor information ratio strategy is to make back make big macrobats in terms of overall direction of markets.

So we're staying pretty close to home in terms of overall levels of risk.

Where we're spending most of our time and where we're allocating most of our risk budget and where we hope to get most of our performance is really in that bottoms up selection.

Just given the amount of dispersion, I think you use the word or I would use the word decompression in terms of definitely one of the themes that we've seen this year the underperformance of the lowest quality part of the hyal market, in addition to the increasing amount of dispersion that we're seeing across sectors and across issuers.

That's really where we're going to get our performance and where we feel the most confidence given the research team that we have given, in the framework and the process that we've developed, that's really where we have the most confidence and where we're going to deliver performance our investors in the current environment.

It's not really in terms of taking directional bets.

You know.

Again, you know, spreads are pretty tight, yields are I would say about average, it's not the best time to be investing in HYGYLID.

I would argue, that's not the worst time.

You just need to know what you're getting into.

You know, what the higher market today offers is I would argue, pretty attractive amounts of yield and income with probably a tighter range in terms of the upside and downside, you know, because of where valuations are and because of where duration is.

As part of we haven't talked about this, but the higher market is a lower duration market today as well.

It does cap your upside a little bit, but because it's lower duration and higher quality, it also capture downside.

So I would I would argue that the higher market today is different than the higher market before.

Some of that's good.

Some of that's bad.

It doesn't give you as much upside, especially given where current valuations are.

But I would argue that the downside that people are usually fearful of in the high yield is unlikely to materialize to the same magnitude this this go around.

Yeah, I think that's to pick that up.

I think that's an interesting point.

You know what, I've noticed that I think we've seen a migration at least in terms of credit quality as you sort of defined by ratings being more heavily weighted towards the double btre today and fewer guys in that basket with trible hooks, right, So you know, with that being the case, how are your funds positioned?

Do you guys overweight double b's given the economic angst you guys see with some select exposure and that sort of deeply high yield ban and you know, obviously you highlight it.

The structure of the market is naturally a shorter duration.

But you know what type of duration we're talking very short term or we're talking three to five year bucket, five to seven or seven plus plus years for you guys, where you guys comfortable at?

Yeah, so we don't take duration bets in our funds, Matt.

You know, the duration comment that I made earlier was really around market composition, Like the duration of the entire market is shortened, shortened by you know, depending on what time payer you compared to, you know, a year, a year and a half over the past ten to fifteen years, and that does have some significant implications for the expected return profile of the market.

The market is just shorter.

Part of that is, you know, issuers have refinanced a lot of debt, but on average, the tenors have probably not been as long as they have historically.

You know, there's there's there's a lot of different reasons for why the market is shorter today, so we're not really looking to take on large rate bets within the funds.

On the credit quality side, we do have a structural bias to be higher quality that the empirical analysis, and conceptually it does make sense to be higher quality within high yield.

Again, risks are asymmetric in fixing income.

In general, you don't have a ton of upside.

You have a lot of downside that is accentuated in a market like high yield, where you know your biggest risk is companies not paying you back the money that you went to them, and so the potential downside can be large, but you have pretty limited upside, you know, if you're right.

So conceptually it makes sense to have an up and quality bias in a market like high yield.

We do have a structural tilt towards being higher quality within high yield from a portfolio perspective, but there can be and are really really interesting opportunities down in quality.

I view the triple C part of the market as more of a id iso syncratic stock picking type of environment liquidity, yeah, exactly, as opposed to an allocation to a down in quality bit.

Right.

If I think about some of the most interesting opportunities that we see there, it's really in where characterized as bottoms up kind of you know, it is 'cratic type of opportunities where we have high conviction either in a particular issuer and therefore we are happy to go down in the capital structure happens to be triple C rated in that in that issue and or you know issuers that may be going through some period of stress and that you know, we have some belief that you know, they have the ability to repair their balance sheets and turn things around, and so we're happy to invest in some of the riskier issuers on that basis as well.

So you know, less of an allocation to down in quality, more a reflection of this high dispersion environment where we have C and D compression, and so there are certain situations in the triple C portion of the market where we feel like you are getting paid for the risk.

Yeah, I think you know when history shows it.

The FED obviously cutting rates is really because of a weakening macro economic backdrop right or potential recession, which see would seem to be a pretty large threat to high old issuers in your portfolio in general.

So if I look at m ip R on the terminal for those of you home, you can run it.

You can see that for the US at least, it looks like we're going to get one hundred base points of cutting down to about three percent over the next year.

Is that van Guard's house view?

And if so, you know, how do you see that sort of filtering out into the high old issuers?

Is that going to help?

Is it a rising tide lifts all boats or there's where's the sector overweights or underweights for you guys.

Yeah, so I'm not a Ray guy.

I would say that in general, the markets have priced in, have consistently priced in more cuts than have actually materialized.

Well, we are in a rate cut environment, right, We are in an environment, at least for now, where the monetary policy should remain somewhat supportive of credit markets, whether we get one hundred based points of cuts or something more or less than that.

But you hit the nail on the head, Matt, right, like you have to ask not so much how much the rate cuts?

How much are we going to get in terms of rate cuts, but why?

And you are one hundred percent correct that a rate cutting cycle is usually associated with a weaker economic environment.

In any benefit that whereverage issuers get from lower rates is usually more than offset by the fact that the economic environment that this rate cutting cycle is happening in is usually a lot weaker, and that that tends to have much more of an impact than any magnitude or rate cutting cycle itself.

And so to the extent we to the extent the FED is cutting rates because they see a weaker econ economy here in the US, that will not be good, That will not be good for leverage credit in general certainly won't be good for the kind of down and quality issuers.

That won't necessarily mean that they have easier access to capital markets.

In fact, usually the opposite occurs, and so the why, which, as you reference, is usually much more important than the what right, the what being a rate cutting cycle, but the why being a weaker economic environment is usually the much more important factor.

How nimble can you be in this market than Michael?

I mean, it's not mentioned to the you know, it's a trillion dollar platform you have.

It's not Matt goidtn AT LLC sitting in New Jersey moving thousand dollar lots around.

You actually have to take pretty big positions.

And so how easy or difficult is that?

Well, it's never easy, James, you know, whether you're managing you know, a billion or ten billion.

One of the realities of the highal market is the liquidity is there when you don't need it, and it's not there when you do.

And so we need to always be mindful of that when we are thinking about entering or thinking about investing in particular situations.

Right, I think one of the things that investors tend to underestimate isn't so much the cost of entry, but the cost of exit, and that's something that we are very intentional about as we think about building our portfolio.

Right, Our portfolios in general are built for the long term.

Our time horizons for investing tend to be very long term oriented.

We're not looking to generate out performance by trading the markets on a daily basis.

And so one of the nice things for us, given the scale that we have is our processes and our time horizons are built to scale, are built to scale to be able to manage across large sums of money, and also built so that most of our our performance is driven more by long term views as opposed to the kind of the daily very you know, daily moves in the market.

You know, that's not to say that we can't and aren't opportunistic in terms of trying to take advantage of opportunities as they pop up.

You know, but as you referenced, right, you know, liquidity is is can be hard to come by, especially in a market like high yield, and we do need to be cognizant of that.

And the good news is, you know, again, the way we think about investing does tend to be more long term oriented, and that does tend to lend itself well to not being as reliant on needing liquidity on a daily basis.

We are you know, much better positioned as providers of liquidity.

You know, we have plenty of dry powder in general to be able to deploy when those dislocations do occur in the market, and so we're I would argue, on the other side of that, right, we can take advantage of the relative illiquidity of the market because in general, you know, we're a little bit more patient and disciplined around how and when we deploy our risk and capital.

So that implies you have fairly large cash balance right now.

How does it compare to history?

Yeah, I was gonna ask the same question.

I'd be curious.

Yeah, so it depends on the fund I would say, you know, within within the high O dedicated strategies, we probably are reserving a little bit of extra cash.

Just given where valuations are, the opportunity cost right now of holding a little bit of extra cash our view is pretty low.

You know, evaluations were to reprice wider, I would say that the cost of holding that liquidity extra equidity would be higher.

But you know, just given where valuations are, I guess that's the flip side.

One of the positives is holding extra cash isn't costing us that much, and so you know, we are reserving a little bit of extra liquidity right now because we do think that there can and will be additional opportunities that pop up in the near future.

You know, we're kind of going through earning season right now in the high yield market, and you know, part of what we're seeing is is an earning season of haves and have nots, right and in the case of have nots or in the case of companies or issuers that are you know, disappointing relative to expectations, we're seeing some pretty outsize price moves as investors have you know, relatively little patients right now for for disappointment, and you know, we are again opportunistically using our extra cash to take advantage of some of those opportunities on an issuer basis.

So when we talk to a lot of portfolio managers who can invest across asset classes, they do flag opportunities.

Instruction finance, you know it he is safe.

There are triple A rated trunches, it's you know, pooled, so you're diversifying your risk but how do you see that?

I mean, you know, we we've been around long enough to know what happened last time there was a big boom instructured finance.

What what what signals are you getting from that?

So I'm a big believer James and the fact that there's no free lunch, and certainly that should applied all financial markets.

And anybody that tells you that that there's you know, excess return to be had, relativity and a risk, I would say is there's probably something else going on.

Again, I can't speak specifically to structor finance.

I'm you know, focused on the higo market.

But as you think about what you're supposed to get paid, you know, what do you what do you get paid when when you're buying a bond, whether it's a higher bond or a structure of finance bond, private credit mode is some element of anticipated future credit losses and risk premium on top of that.

And part of that risk premium in some of these markets may be some component of mark to market premium and some of it may be liquidity premium.

And I would I would say that you know, as you go into some of the more esoteric parts of the financial markets, you know, the lines get a little blurry in terms of are you getting paid for?

You know, what are you getting paid in terms of the yields and spreads and so you know, structure finance is, you know, probably a pretty attractive market.

We we do and it can invest in instructor finance across many of our credit funds.

Again, you just need to know what you're getting yourself into, right, and you know what you're getting paid for, and you know, oftentimes it can make sense to invest in structure finance bonds or higher bonds.

You know, the transparency, the information that you get, the level of granularity does vary across different types of assets, different types of asset classes.

You should and you demand more compensation for that.

The liquidity or lack thereof can vary across asset classes.

You can and should demand different types of compensation for that.

Again, it's all risk return.

I would say that, you know, I would guess that structure finance is no different than the high market in terms of it being essential to do that bottoms up analysis and to kind of know what you own.

So what are some of those sectors where you are where you do see your margetting paid that that sort of risk prome.

Like, obviously it seems like you're the theme is defensive, so is that healthcare?

Is it staples or utilities, guys or A and D like where you see that right now?

Yeah, I got to be honest, Matt.

Right now, when I think about kind of sector valuations, nothing is standing out in terms of things that look really cheap.

And actually that's part of the reason why, at least at a sector level or at an industry level, we'll gravitating a little bit more towards more of the defensive industries, things like utilities or consumer products, food and beverage, because our view right now is, given where those sectors trade, or some of those sectors trade, you're not getting paid that much more to go into some of the more cyclical or riskier sectors at a top level.

Right That's not to say that there aren't interesting situations in some of these other sectors at the issuer level, but just at a sector level, the dispersion level across most sectors not that high.

Again, the uncertainty level, given what's going on in the macro, I would say, is above average.

So why not be a little bit more defensive from a sector perspective right now, and take more of your risk at the kind of the bottoms of a single name level, so you know, sector level, staying a little bit more defensive and taking our shots really more on the bottoms up atosymocratic issuers where you know, based on the deep fundamental analysis that are researched are doing.

We feel really good about the risks that we're taking.

On utility, so they always sound safe, but that being kind of dragged into this whole AI boom.

They will be used to power all that stuff.

So is that going to be risk of much more issuance or other associated risk.

Yeah, we have seen a bit of a tick up, James in some of the issuance on utilities.

Would I would say, we haven't seen that much so far in terms of supply related to you know, some of the AI power demands.

We've seen a little bit, but not that much.

I would expect to see more.

You know.

The the utility sector in high yield is one of those sectors that is I would say emblematic of the higher market overall.

It used to be a riskier part of the market.

There used to be a lot more issuers that that were you know, I would say taking more bets on underlying commodity prices and using kind of leverage balance sheets to do so, and that combination doesn't work super well.

What we see right now within utilities by and large companies that have de risked their both their business profiles as well as their balance sheets.

And so even if they do come to market with more issuance, they have plenty of kind of financial capacity to do so.

And so we haven't.

We haven't seen a ton of frath so far or elevated amounts of issuance in utilities, yet that could change.

Obviously, we have seen more AI adjacent issuance in the high yeld market and so you know, again as of now, we haven't seen it that much, but that could change over the next six to twelve months.

Which is that to see you noted earlier how different the highield market is now compared to let's say ten years ago.

A lot of it seems to be to do with private credit and how much have the suppli has possibly gone there and how that makes maybe the the supply demand imbalance worse and keep spreads tights.

But also you know, we have seen a lot more so called liability management exercises, which they look like defaults, but they are maybe not counted by some agency.

So I'm wondering how you fat that into your your investment process sitting on the leverage loan side, which is where they seem to be most prevalent.

Yeah, I mean, liability management exercises or lemies are are relevant to both high yield as well as loans.

You know where we are this year is it's been happening a little bit more on the loan side, but that in part because we saw so much of it happen in the high old side and in twenty twenty four, and so you know, I would say liability management exercises remained somewhat elevated across leverage finance today relative to history, but have come down a little bit in the highal market relative to off relative to like historic highs in twenty twenty four.

So I would say peak lmy activity in high yield for this cycle is most likely to have occurred in twenty twenty four.

And you know, what we're seeing in the loan market is a bit of a you know, catch up to that.

Lmes are are a big deal.

It's a big way for us to actually add value for our investors.

It's it's a different type of process that we need to manage through above and beyond traditional credit underwriting, different skill set, different type of experience required, but has the potential to add a tremendous amount of value.

To be clear, we we we would include lemis as defaults.

We treat them as defaults even if they aren't actual defaults.

So any default you know statistics that that we you know, look at and or you know expect default rate that we that we think about on a go forward basis, we will always think about and include l activity as part of those as part of those statistics.

You Lems in and of themselves not not a good or bad thing.

They do have the potential to be a bit of a win win relative to more traditional defaults.

Part of the biggest win as it saves a lot in terms of legal fees, and that actually is not insignificant.

The danger of lemies, at least historically has been you know, a bit of a free for all or a bit of a wild wild west is because they're not going through traditional bankruptcies.

Uh, there's a lot more, there's a lot bigger range in terms of potential outcomes, and so you know, part of what we've learned, part of what investors have learned over the past couple of years is in order to maximize value in general, it's a lot better to work together than to fight amongst ourselves, uh, in terms of how to maximize value for for for each investor.

And so you know, I think the market has learned over the last couple of years to manage lemes better in order to uh, not just to further market interest, but also you know, from an individual investor as well.

But to be clear, how do you actually make the value is it?

Is it you buy the asset when people are selling and the full of a critical mess to litigate otherwise pressure to get much more back on your investment.

Yeah, so we're we're not in distressed investors, James.

So that's not really part of our playbook.

You know.

What we do within companies that are going through some element of distress or stress is really thinking about how do we maximize value for investors?

And oftentimes that is not selling when things go bad, but actually rolling up our sleeves and being willing and able to hold on to bonds and loans even in the face of you know, you know, a pretty challenging fundamental situation, especially in situations where we believe that the problems are temporary and that if we hold on, that's the way to maximize value for our investors.

And you know, how we have been able to maximize value oftentimes has been through work together with other like minded creditors in order to negotiate or you know, come to mutually beneficial outcomes with you know, creditors and at time or or debtors and at times private equity sponsors.

And so it's not so much you know, building a sizeable position, although given our scale, you know, we have sizable positions in pretty much everything that we own.

And how we maximize value for us isn't necessarily buying more, but really managing through those situations oftentimes in you know, with other like minded investors.

That's the sense of that they've kind of gone away a bit in the US.

Do you is that does the temporary height heights is are they coming back in in you know, large quantity?

Do you think, lemies, I think they're here to stay.

I think that again, investors have learned a lot about how to navigate through the lem situations that, on the one hand, is good because it you know, again maximizes returns for dead investors.

On the other hand, it could potentially reduce or depress the number of future lemy exercises.

You know, part of why lemis became so popular over the last few years is it allowed issuers or debitors sometimes private equity sponsors to use the greater flexibility of outer court processes to their own advantage, oftentimes by playing creditors against themselves, right, And so part of the reason why lemies became so popular over the last couple of years is because, you know, issuers, private responsors were able to maximize more of their value at the expensive creditors by taking advantage of out of court processes that they could simply couldn't do in a more traditional bankruptcy.

As investors have gotten a little bit smarter and worked a little bit closer together, part of that value what's called reallocation to issuers or private acty sponsors has gone away, and so it's not nearly as beneficial again in general for an issuer to go through an lemy as it used to be.

And so that does have the potential to put a bit of a cap on a go forward basis for future lemy activity.

Okay, okay, that's a leverage finance invested.

Do you prefer leverage loans right now or hild bones It depends.

We do like loans right now.

You know, if you think about tight valuations where most of your return is going to come from let's call it carry an interest, loans are pretty attractive from an asset class perspective because that's what they provide, pretty attractive levels of income.

Being floating rate, you're not taken on any duration risk.

So there is a case to be made for why loans look pretty good.

On the other hand, the loan market is a lower quality market than the higher market.

Some of the improvement in the higho market in terms of credit quality has somewhat common at the expense of some of the lower quality trends that we've seen in the loan market.

So you need to be a little bit careful in terms of looking at loan market valuations compared to high yield because they're not apples to apples.

And that's why I mean, you know, it's what I meant when I said it's kind of case by case, and so there are definitely parts of the loan market that we view as pretty attractive apples to apples versus the HIGHO market where we can pick up pretty decent income and not take on extra risk.

But you just need to be careful not to compare the loan market to the HIGHO market at a top level, because there are some pretty material differences in terms of the underlying composition.

Do you expect supply to increase substantially next year in terms of high yield bonds and loans?

I would say it all depends on the M and A environment twenty twenty five.

As I think back to what everybody was saying, certainly the cell side going into the beginning of this year, twenty twenty five was supposed to be the year of M and A.

This was supposed to be the year where we saw a big pickup in both M and A and LB activity, and that was supposed to drive a big resurgence in primary market activity.

We have seen some we've seen in the HIAL market.

There's been about three hundred billion of issuance year today plus or minus.

We're already ahead of the total amount of issuance that we saw in twenty twenty four, So we have seen a bit of a pickup in primary market activity in high yield, but most of that has been and continues to be for refinancing.

And so as we look forward to twenty twenty six, in order for issuance to take another like higher from current levels, part of what you need to see is that recovery potentially in both M and A and LBO activity.

Yeah.

I think for industrials it's like seventy to seventy five percent has been refi And if you look at at least for the industrials, it's like one hundred billion right now that is callable over the next couple of years, and a third of that is trading at or above the call price right now.

And if you just go within one point, you're looking at close to fifty five percent of the entire industrial sector that is not going to be trading at or above the call prices.

So, like that's that's a spot on observation.

There's definitely I'm going to is what's going to need to pick up to get that net that net benefit for issuance.

Yeah, I mean a couple other factors that could drive additional issuance, you know, AI adjacent issuance.

We've seen a few deals, one of which you mentioned earlier, come hit the highal market, certainly nowhere near to the extent that we've seen in the investment grade market, but you know that that could certainly be a marginal driver of additional issuance in twenty twenty six, which I have to see.

On that side.

The other thing that could move the needle is we have also seen over the course of this year a bit of you know, a return of issuance from the private credit market into the public is syndicated leverage finance market, both the loan and the HIGHO market.

You know, we saw a lot of deals in the private credit market that we're refinancing deals in the loan market, in the higher market in the last few years, and part we've seen this year is a bit of a reversal to that.

Again, not trying to predict that that could happen, but you know, to the extent we continue to see, you know, a bit of additional reversal in terms of more private credit, existing private credit deals being refinanced into either the you know, the syndicated loan market or the higher market.

That could also provide some additional incremental issuance as well in twenty twenty.

Six, But it sounds like it's a lot and in which case we're kind of left under supplies still and you know, spreads remain tight and you know, nothing really changes, so you'll be get a lot more cash next year.

Well, our hope, our hope is again there's there's a lot of different things going on in the world, you know, again, most of which have really no direct impact on high yield, although certainly the economic environment is a big deal.

There's any number of things, given more valuations are that could cause a repricing in the market.

You know, our hope and expectation is that, you know, right now the opportunity cost of steeing relatively neutral on credit is pretty low.

We are ready willing and able to use the dry powder that we have and deploy that as opportunities come up.

Again, you know, we're not short at the market.

You know, it's it's you know, being short hig yield or being short the credit markets over the long term is not really a winning strategy.

So again, our goal right now is not to be short at the market, is to stay pretty close to home, take most of our risk and in the bottoms up opportunities that we see and and wait for a better entry point to deploy and more capital when overall market valuations offer better compensation for us.

And so, Michael, based on your long term strategy for investment and how you look at things, where is the best relative value right now?

So that's that's the million dollar question.

I would say, right now, I love and trillion really yeah, the trillion dollar question.

I would say, right now, it's really hard to find value in credit, and so in the absence of value, it doesn't cost you much to be up in quality our general preference.

So I helped to run multi sactor fonds in addition to our high old portfolios, so that that really runs the gamut between you know, how yould investment great credit, emerging markets, and structure products.

I would say, when I look across kind of the spread sectors within credit, we see most value in some of the higher quality parts in the market.

Our preference right now is on balance investment grade credit over high yield.

We've got a bit of a tilt for higher quality within high yield relative to lower quality.

And so you know, again the opportunity cost of being up in quality right now, given where valuations are is pretty small.

That again, that could change, and so I would say the biggest opportunity right now that I see in corporate credit is to stay up in quality because you're not really being penalized right now, and to reserve that dry powder in capital for hopefully better opportunities ahead.

It's really tough to make a case, at least within publicly traded credit that there are tremendous opportunities to make tremendous outsize returns just given where valuations are right now, and.

The trigger for you to jump back in really is just valuation.

Then it's not anything you know, material in the macro sets up all the rates or anything like that.

You know, our macro you know view right now is is someone benign.

We're not calling for a recession.

Certainly, there's there's a lot of uncertainty around.

We're going to get more data, you know who.

Everyone's waiting for more data, so maybe our our view you know, potentially changes.

I think we'll be on the lookouts as many investors are on what some of the data suggests in terms of the future path of the economy as well as monetary policy.

I would say, in the absence of a change in our macro view, which is somewhat benign here in the US, fundamentals should stay pretty strong, technical should remain somewhat supportive, And so it really just comes down to valuations.

What level of high yield spread would jump you back into the market, though, what's the what's the what's the turning point for you?

Well, I would say it all depends, right, just like rates, it all it'll right, you know, spread spreads usually move for a reason, right, I would say, in the absence of any change in the economic environment, you know, it probably won't take that much more in terms of spread white before we see valuations that look a little bit more compelling and or where our view is it's being expensive not to be longer risk than we are.

Right, My belief is that it is unlikely that spreads are going to widen significantly without something having happened, and so we just need to figure out, you know, when that something happens, how impactful that is, If at all it is too kind of high yield fundamentals and or technicals to the extent it's simply a repricing of that risk premium back to more normal levels.

I would view that as more of a buying opportunity than an event that would cause us to reconsider our macro view and or our view on future default rates.

Great stuff, Michael Chang, head of High Yield Corporate Credit at van God many thanks for joining us today on the Credit Edge.

Great Thank you guys, and thanks thanks for having me.

And of course I'm very grateful to joint up from Bloombag Intelligence.

Thanks for joining us today.

Thanks jeving to be back.

Thanks Mike, much appreciated for.

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