READ THE ORIGINAL
Published in full and free by Oaktree Capital Management. This page indexes its arguments; it is not a copy.
THE ARGUMENT
Written with spreads among the narrowest on record, this is his answer to the question clients kept asking. The test is not whether a spread is historically narrow, he argues, but whether it covers the credit losses that actually occur — and on his own 39-year record it does. He says up front that this comes closer than usual to talking his book.
What it actually claims
He rejects the usual reading: a spread is a fear gauge reporting what investors expect defaults to be, not what defaults will be.
The test he substitutes is whether the spread offsets credit losses — and by his arithmetic today’s would have covered the past.
- a spread around 290 bps, one of the narrowest since high yield issuance began in 1977-78
- against a normal range of 350-550 bps when he managed, revised more recently to 400-600
- default rates averaging 3.5% from 1986 through 2024, costing about two-thirds, or roughly 230 bps a year
The historical spread is not necessarily the standard for adequacy, he argues, since it paid holders well beyond their losses.
- high yield returned 7.83% a year from 1986 through 2024 against 5.14% on 10-year Treasurys
- an advantage of 269 bps a year
He then discounts his own average, since a handful of crisis years pull it well above the typical experience.
- only 14 of the 39 years at or above 3.5%, and 25 below
- a 3.0% average across the remaining 31 years once the crisis and best years are removed
- a median of 2.7%
The universe is also better rated than it was, mostly because triple-B companies chose leverage over holding their rating.
- BB rose from 32.7% at the end of 1999 to 52.6% at the end of 2024
- B fell from 54.6% to 33.7%
- CCC and below barely moved, 12.7% to 13.7%
Buying at the all-time tight just before the crisis still worked over ten years, so a narrow entry spread is not destiny.
- the all-time tight of 241 bps on June 1, 2007
- high yield trailed Treasurys by 11.3 percentage points in the first year
- then beat them by about 3 points a year over the following 10 and 15 years
On private credit the tide has never gone out, he says, and the risk he names is manager behavior rather than something systemic.
His conclusion is relative, not absolute: credit is no giveaway, but it out-yields equities and its returns are contractual.
- J.P. Morgan Asset Management: from p/e ratios like today’s, the S&P 500 has historically produced ten-year returns averaging between -2% and 2% a year
- the 10-year Treasury yield above the S&P 500’s earnings yield (Wall Street Journal, January 27)
Figures are the author's own, as cited in the memo.