The global diversifier: the case for European credit

Given the volatility currently roiling the rest of the world, investors are looking to Europe as a relatively stable alternative. European credit has seen substantial growth over the last couple of decades and offers strong fundamentals, as well as acting as a global diversifier.

What is the opportunity now?

Despite some headwinds created by tariff volatility, Europe also benefits from certain tailwinds, such as Germany’s decision to release the debt break earlier in 2025. This will create €500 billion additional funds for infrastructure spending, alongside a boost for defence spending¹. This added fiscal impulse could boost European growth as the largest economy engages in a fiscal expansion. Furthermore, Europe currently benefits from lower interest rates than other developed market counterparts, further fostering a supportive environment for growth. 

In this scenario, where the path of global growth is uncertain, European credit can potentially offer good diversification qualities and a potential yield pick-up. Although only incrementally, up until very recently European credit traded at a higher spread compared to US credit. In our view, we suggest this modest spread differential offers attractive yield opportunities for investors seeking enhanced returns in a relatively stable credit environment.

European credit also serves as a valuable global diversifier. Despite its potential, it remains internationally under-invested. Consequently, this provides an opportunity for investors to gain exposure to a market where demand/supply dynamics are more in favour of investors.

Duration matters

As the global economy stands at a crossroads, with the next stage of the economic cycle unclear. The ongoing tariff story has created uncertainty about the trajectory of inflation, with many of the effects yet to be seen. In turn, this could constrain the Federal Reserve in making further cuts. Meanwhile, the rest of the world awaits to see if US tariff policy will export inflation once more, with the European Central Bank leaving interest rates untouched in July as it awaits to see the impact.

As such, there are benefits to active duration management. The duration lever can create a significant opportunity to react to interest rate volatility, while short duration can offer defensive qualities in periods of uncertainty.

Remaining agile

Flexibility is critical in today’s market – it should be the cornerstone of effective fixed income strategies. Markets are inherently dynamic, and the ability to pivot across asset classes, geographies, and maturities can make a significant difference in portfolio performance.

During the COVID-19 pandemic, for example, fixed income markets experienced significant dislocations, particularly in credit. Investors who acted decisively to increase allocations to high-quality corporate bonds reaped significant rewards as markets stabilised. Conversely, reducing portfolio duration during the inflationary pressures of 2022 helped preserve returns.

Markets reward those who can act decisively and strategically, rather than adhering rigidly to a fixed allocation; and these scenarios highlight the importance of agility and flexibility in capturing opportunities and managing risk.

Benefits of being defensive

Markets are not static; valuations change and continuously reprice. As such while we cannot forecast the future, we can only dispassionately assess valuations today and how much we will be compensated for taking risk. This could act as an important steer as to which segments of the market are attractive.

Credit spreads have been historically tight. However, credit spreads can, and do, move aggressively and often without warning. While this can be concerning, we believe this is the prime time when active management pays as cheap markets do not sell off, but expensive markets do; all it takes is a catalyst which the market often fails to see. As such, having the flexibility and foresight to be able to retrench from that risk allows you to take the risk on again when you are in a position to be paid for it.

The most important factor is protecting yourself such that you can come back out to play. The last man standing in the marketplace can capture the bargains. In this scenario, having a fundamental credit research team is essential to identify the most compelling opportunities across global credit markets.

Taking advantage of market dislocations

At M&G Investments, we have an experienced team of more than 50 fundamental credit analysts, making it one of the largest in Europe. Each analyst produces proprietary credit ratings for the companies that they cover. Alongside those of the leading credit rating agencies, this helps us to add value through both relative and fundamental opportunities.

While the US credit markets are rightly known for their uniformity (ie based on a single set of laws and rules), the European credit market presents a different landscape. Europe’s market is characterised by its fragmentation, with one monetary policy (the European Central Bank’s) governing 22 nations, each with its own fiscal rules and regulatory frameworks. This diversity can create unique investment opportunities, in our view, as discrepancies and inefficiencies across different national markets can be leveraged by active credit investors to achieve superior returns.

Furthermore, as the European credit market continues to grow, one result of there being a substantially larger opportunity set is that there’s greater dispersion, where bonds with the same credit rating trade at different credit spreads over government bonds. High levels of dispersion are often found during periods of market volatility such as today and can provide a rich source of opportunities to identify mispriced securities through in-depth credit analysis.

There is a high level of dispersion within BBB-rated bonds, as can be seen in the graph below, meaning that there are significant value opportunities to be uncovered. We believe we can capture higher spreads while taking the same level of credit risk. Making these decisions could produce some attractive outcomes for fixed income investors; we often think of equities delivering capital upside, while fixed income delivers the yield on the tin, but for active investors, this does not have to be the case.

In this environment, we believe European credit can act as a strong global diversifier against a volatile global backdrop, while flexibility and active management will be a differentiator to capitalise on attractive opportunities. Furthermore, agility and fundamental research will be increasingly important to avoid the pitfalls such a volatile market can bring, maintaining the ability to deploy capital when the risk/return pay off arises once more. 

¹ https://www.bundesregierung.de/breg-de/aktuelles/sondervermoegen-2356240

The value of investments will fluctuate, which will cause prices to fall as well as rise and investors may not get back the original amount they invested. Past performance is not a guide to future performance. The views expressed in this document should not be taken as a recommendation, advice or forecast, nor a recommendation to purchase or sell any particular security.