Summary
U.S. corporate credit markets delivered mixed performance in the fourth quarter, as the U.S. yields rose while corporate credit spreads tightened modestly. After a strong third quarter, the Bloomberg U.S. Aggregate Bond Index returned -3.06% during the quarter and finished 2024 with a total return of 1.25%. Similarly, after a strong third quarter, investment grade corporate bonds underperformed both high yield bonds and bank loans, as the Bloomberg U.S. Corporate Bond Index returned -3.04% for the quarter and 2.13% for the year. The Bloomberg U.S. Corporate High Yield Bond Index ended the quarter marginally higher, with a total return of 0.17% for the quarter and 8.19% for the full year. Bank loans posted strong gains, with the Credit Suisse Leveraged Loan Index gaining 2.29% for the quarter and 9.05% for the year.
U.S. equity markets continued to rally in the fourth quarter, with the S&P 500 Index gaining 2.41% during the quarter and 25.02% in 2024. Strong risk sentiment was bolstered by a resilient U.S. economy, two rate cuts and increased expectations for potential deregulation and pro-business policies following the U.S. presidential election. U.S. economic growth remained strong, with third-quarter real GDP growing at an annualized rate of 3.1%. Although the unemployment rate edged up to 4.2% in November, strong non-farm payrolls growth helped offset this increase. Inflation remained elevated, with the annual inflation rate picking up to 2.7% in November, after bottoming out at 2.4% in September.
The Federal Reserve (Fed) implemented two consecutive rate cuts at its November and December meetings, taking the federal funds target rate to a range of 4.25% to 4.50%. Additionally, the Fed signaled a shift toward a more neutral stance at the December meeting, as Chairman Powell indicated the Fed is likely to take a more measured approach moving forward. The committee updated their projections to forecast only two rate cuts in 2025, while interest rate futures markets ended the year pricing in less than two cuts through the end of 2025.
Market Environment
Despite 50 additional basis points in rate cuts from the Fed, intermediate-to-longer U.S. Treasury yields rose during the quarter, as the yield curve bear steepened. After falling sharply in the third quarter, the yield on the U.S. 2-year note rose roughly 59 basis points during the quarter, ending the year just 2 basis points above where it ended 2023. Meanwhile, the yield on the U.S. 10-year note rose approximately 77 basis points for the quarter, ending the year near 4.58%, 70 basis points higher on the year.
Corporate credit spreads continued to narrow during the quarter, with both high yield and investment grade spreads approaching levels not seen in over a decade. After falling to a low around 253 basis points after the November elections, high yield spreads widened modestly into year-end, finishing the quarter around 8 basis points tighter overall, as measured by the Bloomberg U.S. Corporate High Yield Bond Index. Investment grade corporate bond spreads narrowed to near 74 basis points in November and ended the quarter 9 basis points tighter overall, as measured by the Bloomberg U.S. Corporate Bond Index. For the full year, high yield and investment grade spreads narrowed by 36 and 19 basis points, respectively.
Primary markets remained strong throughout the quarter. High yield bond issuance topped $49 billion in the fourth quarter, an increase of more than 15% compared to the fourth quarter of 2023. Leveraged loan issuance continued at a record pace, exceeding $418 billion during the quarter, an increase of more than 250% compared to the same period in 2023. For the full year, high yield bond supply totaled approximately $289 billion, a 61% year-over-year increase, while leveraged loan issuance set a new all-time high above $1.3 trillion. Investment grade issuance also remained robust, with supply topping $1.5 trillion, the second-highest annual total on record, trailing only 2020.
High yield bond and leveraged loan funds both experienced net inflows during the quarter. High yield bond inflows topped $1 billion for the quarter, taking the year-to-date total to approximately $16.4 billion. Leveraged loan funds reversed earlier outflows prior to the September rate cut, attracting roughly $11.7 billion in net inflows during the fourth quarter and $21.1 billion for the full year.
Within the high yield bond market, lower-quality bonds added to their year-to-date gains during the quarter, with CCC-rated bonds (+2.3%) outperforming B-rated bonds (+0.3%) and BB-rated bonds (-0.5%). On a year-to-date basis, CCC-rated bonds outperformed B- and BB-rated bonds by 7.7% and 8.8%, respectively. From an industry perspective, Telecommunications (+2.1%) and Transportation (+1.8%) outperformed, while Real Estate Investment Trusts (REITs) & Real Estate-Related (-1.5%), and Healthcare (-1.4%) underperformed.
Distressed exchanges drove default and distressed activity during the quarter, as the gap between the leveraged loan and high yield par-weighted default rates rose to its highest since 2000. The 12-month trailing, par-weighted U.S. high yield default rate, including distressed exchanges, declined by 17 basis points, ending the quarter at 1.47% (0.36%, excluding distressed exchanges), about 141 basis points lower year-over-year. Meanwhile, the leveraged loan par-weighted default rate, including distressed exchanges, rose by 78 basis points to 4.49% (1.52%, excluding distressed exchanges), approximately 122 basis points higher year-over-year).
Performance and Attribution Summary
High Yield Bond
The Aristotle High Yield Bond Composite returned 0.11% gross of fees (0.09% net of fees) in the fourth quarter, outperforming the -0.18% return of the ICE BofA BB-B U.S. Cash Pay High Yield Constrained Index. Security selection was the primary contributor to relative performance. Industry allocation and sector rotation also contributed to relative performance, with no offsetting detractors.
Security selection contributed to relative performance, led by holdings in Energy and Finance Companies. This was partially offset by selection in Pipelines & Distributors and Transportation. Industry allocation also contributed to relative performance, driven by overweights in Energy and Transportation. This was partially offset by an underweight in Telecommunications and an overweight in Utilities. Additionally, sector rotation contributed marginally to relative performance, led by the allocation to cash, partially offset by the allocation to investment grade corporate bonds.
| Top Five Contributors | Top Five Detractors |
|---|---|
| Community Health Systems | Suburban Propane |
| Enerflex | New Fortress Energy |
| Air Lease | LABL |
| Navient | Sunoco |
| MPT Operating | Level 3 Financing |
Short Duration High Yield Bond
The Aristotle Short Duration High Yield Bond Composite returned 0.68% pure gross of fees (0.55% net of fees) in the fourth quarter, underperforming the 0.82% return of the ICE BofA 1-3 Year BB-B U.S. Cash Pay Fixed Maturity High Yield Constrained Index. Security selection was the primary detractor from relative performance, while industry allocation contributed to performance.
Security selection detracted from relative performance, led by holdings in Pipelines & Distributors and Paper & Packaging. This was partially offset by selection in Finance Companies and REITs & Real Estate-Related. Sector rotation also detracted from performance, led by the allocation to investment grade corporate bonds, partially offset by the allocation to cash. Industry allocation contributed to relative performance, driven by overweights in Energy and Pipelines & Distributors. This was partially offset by overweights in Chemicals and REITs & Real Estate-Related.
| Top Five Contributors | Top Five Detractors |
|---|---|
| Navient | New Fortress Energy |
| Energy Transfer | Mercer International |
| MPT Operating | RHP Finance |
| Sunnova Energy | Tri Point Group |
| Liberty Latin America | Zayo Capital |
Outlook
We maintain an optimistic outlook for U.S. corporate credit markets heading into 2025. Strong corporate fundamentals, a resilient U.S. economy, and supportive technical factors provide a solid foundation. All-in yields remain attractive, and the pro-business policy narrative following the U.S. election suggests potential deregulation and corporate tax cuts that could further support credit markets.
A resilient U.S. economy continues to dominate the macroeconomic backdrop, with above-trend growth, strong consumer spending and a solid labor market. Globally, however, economic divergence persists. While China’s September stimulus provided short-term stability, it has not resolved longer-term structural issues such as the real estate overhang and weak credit demand. Meanwhile, Europe’s economic struggles continue. With the potential for new tariffs and trade policies under the new Trump administration, the U.S. will likely remain a relatively bright spot in a volatile global economy.
Inflationary pressures have moderated, but the pace of deceleration has slowed, with inflation ticking up from September’s low. Despite the move lower in front-end rates during the quarter, longer-dated yields reversed course, reflecting fiscal concerns and persistent inflation risks. The pace of further rate cuts will depend on continued progress in reducing inflation and stabilizing labor market conditions. With a more volatile political backdrop and potential inflationary policies in the form of tariffs and restrictive immigration, the risk to longer-end rates continues to be to the upside. Furthermore, lower front-end rates have eased refinancing pressures in the high-yield market, but highly leveraged credits may still face challenges if rates have already bottomed for the cycle.
Corporate credit fundamentals remain healthy, supported by earnings growth and modest leverage increases among high-yield issuers. Technicals are also supportive, with continued strong demand, and a steepening yield curve making U.S. fixed income attractive for foreign buyers. The U.S. election results have increased expectations for deregulation and pro-business tax policies that could reduce funding costs and spur corporate investments. A shift from refinancing-related issuance to M&A and share repurchase-related issuance could be positive in the short term but may have negative longer-term consequences for overall fundamentals. Additionally, risks including geopolitical tensions, persistent inflationary pressures and sector-specific challenges—particularly in industries facing secular decline—may create headwinds. Furthermore, we believe market volatility could increase if fiscal policy uncertainty or tightening financial conditions reemerge.
Looking ahead, we remain committed to disciplined credit selection, focusing on what we believe to be higher-quality issuers with sustainable tailwinds and solid balance sheets. Given the potential for a bumpy geopolitical road ahead, we will continue to monitor macroeconomic developments closely, seeking to ensure we are well-positioned to capitalize on attractive opportunities while mitigating risks in an evolving market environment.
High Yield Bond Positioning
In our high yield bond portfolios, we continue to focus on BB/B-rated credits in the short-to-intermediate part of the curve. During the quarter, we increased exposure to BB-rated credits and marginally reduced exposure to B-rated credits. We also maintained exposure to select investment grade-rated credits and increased duration exposure to align with the benchmark. We continue to focus on sectors with strong fundamentals and issuers we believe should benefit from specific tailwinds, allowing resilience throughout the economic cycle.
In the fourth quarter, the high yield market saw an extension of the low-quality rally that began earlier this year, as market participants likely continued to chase performance into year-end. We remain cautious on this segment of the market, particularly credits in industries facing secular decline that outperformed in the second half. Our focus remains on relative value opportunities within the higher-quality segment of the high yield market. Furthermore, we are focused on opportunities in the secondary market, given tight spreads in the primary market.
Looking ahead, we are seeking to align our portfolios with a few key themes in 2025. These themes include U.S. exceptionalism and potential M&A opportunities, where high yield companies could benefit from strategic acquisitions. As a result, we further reduced credits with significant non-U.S. exposure and are focused on industries where we see favorable tailwinds. From an industry perspective, we continue to identify opportunities in Pipelines & Distributors and Manufacturing & Construction, while avoiding highly leveraged credits in Cable & Satellite and Telecommunications. At the end of the quarter, we held overweights in Transportation, Retailers & Restaurants and Energy alongside underweights in Technology, Healthcare and Telecommunications.
All investments carry a certain degree of risk, including the possible loss of principal. Investments are also subject to political, market, currency and regulatory risks or economic developments. There are risks specifically associated with fixed income investments such as interest rate risk and credit risk. Bond values fluctuate in price in response to market conditions. Typically, when interest rates rise, there is a corresponding decline in bond values. This risk may be more pronounced for bonds with longer-term maturities. Credit risk refers to the possibility that the bond issuer will not be able to make principal and interest payments. High yield securities are generally rated lower than investment grade securities and may be subject to greater market fluctuations, increased price volatility, risk of issuer default, less liquidity, or loss of income and principal compared to investment grade securities.
The material is provided for informational and/or educational purposes only and is not intended to be and should not be construed as investment, legal or tax advice and/or a legal opinion. Investors should consult their financial and tax adviser before making investments. The opinions referenced are as of the date of publication, may be modified due to changes in the market or economic conditions, and may not necessarily come to pass. Information and data presented has been developed internally and/or obtained from sources believed to be reliable. Aristotle Credit does not guarantee the accuracy, adequacy or completeness of such information.
The opinions expressed herein are those of Aristotle Credit Partners, LLC (Aristotle Credit) and are subject to change without notice. Past performance is not a guarantee or indicator of future results. This material is not financial advice or an offer to buy or sell any product. You should not assume that any of the securities transactions, sectors or holdings discussed in this report are or will be profitable, or that recommendations Aristotle Credit makes in the future will be profitable or equal the performance of the securities listed in this report. The portfolio characteristics shown relate to the Aristotle Credit High Yield Bond strategy and the Aristotle Credit Short Duration High Yield Bond strategy. Not every client’s account will have these characteristics. Aristotle Credit reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs. There is no assurance that any securities discussed herein will remain in an account’s portfolio at the time you receive this report or that securities sold have not been repurchased. The securities discussed may not represent an account’s entire portfolio and, in the aggregate, may represent only a small percentage of an account’s portfolio holdings. For a full list of all recommendations made by Aristotle Credit during the last 12 months, please contact us at (949) 681-2100. This is not a recommendation to buy or sell a particular security.
Past performance is not indicative of future results. Performance results for periods greater than one year have been annualized. Composite returns are preliminary pending final account reconciliation.
High Yield Bond Returns: Composite and benchmark returns reflect the reinvestment of income. Composite returns are presented gross and net of investment advisory fees and include the reinvestment of all income. Gross returns will be reduced by fees and other expenses that may be incurred in the management of the account. Net returns are presented net of actual investment advisory fees and after the deduction of all trading expenses.
Short Duration High Yield Bond Returns – Pure Gross: Pure gross returns do not reflect the deduction of any trading costs, fees or expenses. Pure gross returns prior to September 2017 reflect the deduction of transaction costs. Model Net Performance: Starting from September 2017, composite returns are presented pure gross and net of the highest wrap fee stated. Performance for periods prior to September 2017 are presented pure gross and net of actual investment advisory fees.
Aristotle Credit Partners, LLC is an independent registered investment adviser under the Advisers Act of 1940, as amended. Registration does not imply a certain level of skill or training. More information about Aristotle Credit, including our investment strategies, fees and objectives, can be found in our Form ADV Part 2, which is available upon request. ACP-2501-4
Sources: Archer IMS; ICE BofA
*Composite returns are preliminary pending final account reconciliation.
**2014 is a partial-year period of nine months, representing data from April 1, 2014 to December 31, 2014.
***2009 is a partial-year period of ten months, representing data from March 1, 2009 to December 31, 2009.
Past performance is not indicative of future results. Composite returns are presented gross and net of investment advisory fees and include the reinvestment of all income. Gross returns will be reduced by fees and other expenses that may be incurred in the management of the account. Net returns are presented net of actual investment advisory fees and after the deduction of all trading expenses. The Aristotle High Yield Bond strategy has an inception date of April 1, 2014; however, the strategy initially began at Douglas Lopez’s predecessor firm. A supplemental performance track record from March 1, 2009 to December 31, 2013 (Mr. Lopez’s departure from the firm) is provided. The returns are based on a separate account from the strategy while it was being managed at Doug Lopez’s predecessor firm and performance results are based on custodian data. During this time, Mr. Lopez had primary responsibility for managing the account. Please refer to disclosures at the end of this document.
Sources: Archer IMS; ICE BofA
*Composite returns are preliminary pending final account reconciliation.
**2014 is a partial-year period of nine months, representing data from April 1, 2014 to December 31, 2014.
Past performance is not indicative of future results. Composite and benchmark returns reflect the reinvestment of income. Pure Gross: Pure gross returns do not reflect the deduction of any trading costs, fees or expenses. Pure gross returns prior to September 2017 reflect the deduction of transaction costs. Model Net Performance: Starting from September 2017, composite returns are presented pure gross and net of the highest wrap fee stated. Performance for periods prior to September 2017 are presented pure gross and net of actual investment advisory fees. Please refer to disclosures at the end of this document.
The Bloomberg U.S. Aggregate Bond Index is a broad base, market capitalization-weighted bond market index representing intermediate term investment grade bonds traded in the United States. The Index is frequently used as a stand-in for measuring the performance of the U.S. bond market. In addition to investment grade corporate debt, the Index tracks government debt, mortgage-backed securities (MBS) and asset-backed securities (ABS) to simulate the universe of investable bonds that meet certain criteria. In order to be included in the Index, bonds must be of investment grade or higher, have an outstanding par value of at least $100 million and have at least one year until maturity. The Bloomberg U.S. Corporate Bond Index measures the investment grade, fixed-rate, taxable corporate bond market. It includes securities publicly issued by U.S. and non-U.S. industrial, utility and financial issuers that are all U.S. dollar denominated. The Bloomberg U.S. Corporate Bond Index is a component of the Bloomberg U.S. Credit Bond Index. The Bloomberg U.S. Corporate High Yield Bond Index measures the U.S. dollar-denominated, high yield, fixed-rate corporate bond market. Securities are classified as high yield if the middle rating of Moody’s, Fitch and S&P is Ba1/BB+/BB+ or below. Bonds from issuers with an emerging markets country of risk, based on Bloomberg EM country definition, are excluded. The S&P 500 Index is the Standard & Poor’s Composite Index and is a widely recognized, unmanaged index of common stock prices. It is market cap weighted and includes 500 leading companies, capturing approximately 80% coverage of available market capitalization. The ICE Bank of America (ICE BofA) BB-B U.S. Cash Pay High Yield Constrained Index measures the performance of the U.S. dollar-denominated BB-rated and B-rated corporate debt issued in the U.S. domestic market, a fixed coupon schedule and a minimum amount outstanding of $100 million, issued publicly. Allocations to an individual issuer in the Index will not exceed 2%. The Credit Suisse Leveraged Loan Index is a market-weighted index designed to track the performance of the investable universe of the U.S. dollar-denominated leveraged loan market. The ICE Bank of America (ICE BofA) 1-3 Year BB-B U.S. Cash Pay Fixed Maturity High Yield Constrained Index tracks the performance of the U.S. dollar-denominated below investment grade corporate debt, currently in a coupon paying period, that is publicly issued in the U.S. domestic market; including 144A securities, both with and without registration rights. Qualifying securities must have risk exposure to countries are members of the FX-G10, Western Europe, or territories of the United States and Western Europe. The FX-G10 includes all Euro members: the United States, Japan, the United Kingdom, Canada, Australia, New Zealand, Switzerland, Norway and Sweden. Qualifying securities include only those rated BB1 through B3. Perpetual securities are not included as all securities must have a fixed final maturity date. All final maturity dates must range between one and three years. It is a capitalization-weighted index, constrained to 2% maximum weighting per issuer. The volatility (beta) of the Composites may be greater or less than the indices. It is not possible to invest directly in these indices. Composite and index returns reflect the reinvestment of income.
