Rate cuts drive credit investing

INTEREST rates may finally be on their way down, opening the door for a fresh set of opportunities in credit investing.

And the next 18 months could prove fertile ground for both traditional and alternative fixed-income strategies, especially for those willing to look past short-term uncertainties.

Jonathan Mondillo, global head of fixed income at Aberdeen Investments, believes the environment is becoming increasingly supportive for investors who know where to look.

“It’s been a bit stop-start over the past couple of years, but the overall trend for policy interest rates remains downwards,” he says.

“We expect the US Federal Reserve (Fed) to cut rates one or two more times in 2025, followed by three to four more cuts in 2026,” he adds.

The United Kingdom, he notes, is broadly on the same track, although inflation has forced the Bank of England to move more cautiously.

“After one further rate cut in 2025, we still foresee potentially as many as four further UK rate cuts in 2026,” Mondillo adds.

“In this respect, we’re expecting a bit more than what markets are pricing in,” he notes.

That policy backdrop, coupled with resilient corporate fundamentals, sets the stage for some attractive plays.

“Although credit spreads are compressed, all-in yields are still attractive compared to history,” he says. “Corporate fundamentals are robust, with good profitability, low leverage and good interest coverage.”

The sweet spot, according to Mondillo, lies in investment-grade short-dated credit. It offers “attractive long-term risk-adjusted returns and low volatility that may appeal particularly to more risk-conscious investors.”

At the same time, he stresses that a severe downturn is not the base case.

“Selectivity is key because even in tough economic conditions, some higher quality high-yield names can be attractive,” he points out.

Emerging market shines

Beyond developed markets, emerging market (EM) debt continues to shine.

“This year, we have seen quite a significant weakening of the US dollar. Naturally, this has helped local currency EM debt, which is the top-performing segment in 2025 so far,” Mondillo notes.

Frontier bonds are also drawing attention, with higher yields attracting investors despite the risks.

“The de-dollarisation trend has been helpful,” he explains, adding that “some frontier names could be relatively well-insulated from tariff-related headwinds.”

Still, no credit cycle is without risks, and Mondillo identifies three big ones.

The first is geopolitics: “There are geopolitical tensions, especially the ongoing Russia-Ukraine conflict and events in the Middle East. There is also a geopolitical dimension to the trend of increasing global trade protectionism,” Mondillo says.

The second is fiscal. “We’ve been seeing a tendency of increased government deficit spending. The concern for credit investors is that the resulting increase in bond issuance could push up term premia,” he explains.

The third risk is more technical: refinancing pressures at the lower end of high yield.

“In particular, in recent months we’ve been seeing signs of an uptick in the issuance of so-called ‘payment-in-kind’ bonds,” he highlights.

If that paints a picture of public credit markets under scrutiny, the same cannot be said for private credit, which is quietly flourishing.

“We believe an allocation to private credit can play a valuable role in most portfolios,” Mondillo says.

“Private credit offers a unique combination of investor benefits, including higher yields, exposure to a more diverse range of issuers that helps diversification, as well as greater protections such as security,” he adds.

The catch, he concedes, is liquidity.

“Of course, the higher yield feature of private credit tends to be mainly compensation for reduced liquidity. Investors especially need to make sure they are being rewarded for this.”

Another challenge is information flow.

“Private credit is generally less widely available in terms of information regarding borrowers. This really underscores the need for investors to look for fund providers with strong and proven in-house credit research capabilities.”

On the subject of vehicles, Mondillo is pragmatic about passive fixed-income products such as exchange-traded funds (ETFs).

“We think there’s a role for both passive and active investing solutions within fixed income,” he says. But he insists the inefficiencies in bond markets tilt the balance towards active managers.

“Fixed income is an asset class where historically active approaches have tended to fare relatively well, certainly compared to equities,” he notes.

At Aberdeen, he is keen to highlight performance.

“We are proud that 90% and 94% of our active fixed income assets under management have outperformed their benchmarks over three and five -years respectively,” he says.

ETFs, however, still have a place for “lower costs, greater holdings transparency and more trading ease.”

Sustainability is another area where Mondillo sees no turning back.

“We believe sustainability and ESG (environmental, social, and governance) factors are highly relevant for credit investing,” he explains.

“Given the clear materiality of ESG factors for many issuers, we believe a formalised ESG assessment is part of our fiduciary responsibility to our clients.”

Beyond strategy, several structural trends are shaping the market. One is the vast amount of cash waiting to be deployed.

“With roughly US$7 trillion ‘sitting on the sidelines’, we’re seeing increased investor interest in viable ‘step-out-of-cash’ solutions,” Mondillo says.

Aberdeen has responded with its Short Dated Enhanced Income Fund, “an asset class that really ticks many of the boxes.”

Private credit expansion is another theme, and the firm has doubled down with new products.

“Just recently, we launched a dedicated fund finance fund, which invests in investment grade ‘subscription line facilities’. We think it’s a testament to our innovation capability that we can offer exposure to this niche segment in an evergreen format,” he adds.

And then there’s sustainability again, this time driving product development.

“Some examples of our offerings in this space are the Climate Transition Bond Fund, the Global High Yield Sustainable Bond Fund and the Emerging Markets SDG Corporate Bond Fund,” Mondillo says.

Taken together, his outlook is one of cautious optimism. Interest rate cuts should provide a tailwind, but geopolitics and refinancing risks still need careful management.

In the meantime, investors are being asked to balance opportunity with patience, and to choose carefully between public, private, active and passive options.

As Mondillo puts it: “Selectivity is key.”