Whether in sports or financial markets, averages often grab headlines, but they can conceal as much as they reveal. Variation—including the dispersion of metrics like credit spreads for high-yield bonds—is the real story. It’s a barometer of the opportunities where skilled active portfolio managers can add value through security selection, especially when combined with low costs. To paraphrase, variation is the mother of innovation … and excess returns.
In recent months, headline spreads in high-yield bond markets have been tight.1 Investors may believe that tight headline spreads imply a lack of opportunity, but for active managers, the variation—or dispersion—of the underlying securities’ spreads reveals the true potential for generating alpha through security selection.2 While the opportunity to add value exists in any headline spread environment, greater variation around benchmark averages means greater opportunities to identify mispriced market segments or bonds—and the potential to generate excess returns.
How we measured spread variation
To illustrate how variation plays out in different spread environments, the figure below uses five years of monthly bond-level spread data for the Bloomberg High-Yield Corporate Bond Index. First, we bucketed all high-yield bonds by credit quality ratings to account for risk and calculated the monthly variation of spreads in each quality segment. Then, we categorized the monthly results into quintiles based on the headline spread to show variation in lower and higher headline spread environments.
Variation, and the opportunity it grants to active managers, is clearly present in all spread environments across quality segments. It increases as credit spreads widen and is consistently greatest in CCC-rated bonds. With that said, wider credit spreads and lower bond ratings are also signals of greater risk, so making sure these investments are appropriately aligned with the investor’s goals, time horizons, and risk tolerances is paramount.
Variation and opportunity increase with risk
Spread variation in basis points 
If you are considering investing in high-yield bond funds, don’t base your decision on average spreads alone. Variation in spreads provides active high-yield bond managers with opportunities to add value. But manager skill and low costs are crucial.
