Market neutral - Why standing still in credit may carry more risk than investors realise

April 23, 2026

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As volatility returns to credit markets and dispersion increases, a market neutral approach offers investors a way to stay invested while reducing reliance on market direction and capturing relative value opportunities, argues portfolio manager Jamie Cane.

Credit markets are entering a more nuanced phase. While spreads remain relatively tight by historical standards, yields have moved higher, providing a more supportive starting point for returns. This reflects both higher underlying rates and some repricing of risk. Valuations are therefore less stretched than they were at the start of the year but not compelling enough to rely on carry alone.

More importantly, the market environment is shifting. After an extended period of unusually low volatility, markets are beginning to exhibit more frequent and pronounced swings. Macro uncertainty, evolving central bank expectations and geopolitical developments are contributing to a more dynamic backdrop, marking a move away from stable, one-directional conditions. Equity markets, while still resilient, may also become more sensitive to changing expectations, with greater divergence emerging beneath the surface.

For investors, this shift changes where returns can be generated. In low-volatility environments, credit returns are largely driven by carry, with limited differentiation across issuers and sectors. As volatility rises, pricing becomes more dispersed, creating both risks and opportunities. A similar pattern is emerging in equities, where index stability can mask increasing divergence at the stock and sector level.

A traditional long-only approach remains inherently dependent on market direction. Even with higher yields, investors remain exposed to shifts in sentiment and potential spread widening. While carry provides some cushion, it may be insufficient in a more volatile environment. The key question is therefore not just whether yields are attractive, but whether returns are resilient to changing conditions.

A credit market neutral approach offers an alternative by shifting the focus from market direction to relative value. By constructing portfolios of paired long and short positions, returns are driven by changes in relative pricing rather than overall market moves.

As volatility rises, dispersion increases and pricing becomes less uniform, creating dislocations between similar credits, sectors and regions. These inefficiencies, often driven by technical factors or investor flows, are difficult to exploit in long-only portfolios but sit at the core of market neutral strategies.

The current rate environment further supports this approach. With cash rates no longer near zero, market neutral strategies can generate a natural carry component broadly aligned with risk-free rates, before any additional alpha from relative value trades.

These strategies draw on multiple return sources. Basis trades exploit discrepancies between cash bonds and derivatives, relative value trades capture differences across similar credits or regions, and intra-capital structure trades seek inconsistencies within an issuer’s debt stack. All tend to benefit from periods of higher volatility and dispersion.

Market neutral does not mean risk-free, but risk is managed differently. Portfolios are built from many smaller positions, reducing reliance on any single outcome, while leverage is used to balance exposures rather than to take directional bets. The result is typically lower volatility and shallower drawdowns than long-only credit, while still benefiting from positive carry.

For investors, this has clear implications. Market neutral credit is not a replacement for long-only exposure, but a complement, providing a return stream driven by pricing inefficiencies rather than market direction and helping to diversify portfolios alongside traditional credit and equity allocations.

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Index descriptions

HEC4 – The ICE BofA BB-B Euro High Yield Constrained Index contains all securities in the ICE BofA Euro High Yield Index (HE00) rated BB1 through B3, based on an average of Moody's, S&P and Fitch, but caps issuer exposure at 3%.

HUC4 - The ICE BofA  BB-B US High Yield Constrained Index contains all securities in the ICE BofA  US High Yield Index (H0A0) that are rated BB1 through B3, based on an average of Moody’s, S&P and Fitch, but caps issuer exposure at 2%.

S&P 500 - The Standard & Poor's 500 Index (S&P 500) is an index of 500 stocks seen as a leading indicator of U.S. equities and a reflection of the performance of the large cap universe, made up of companies selected by economists.

Euro Stoxx -The EURO STOXX 50 Index, Europe's leading blue-chip index for the Eurozone, provides a blue-chip representation of supersector leaders in the region. The index covers 50 stocks from 11 Eurozone countries. The index is licensed to financial institutions to serve as an underlying for a wide range of investment products such as exchange-traded funds (ETFs), futures, options and structured products.

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