High ratings no longer equate to the best returns: supply and duration are reshaping the quality premium in credit markets

Overview

The report re-examines the concept of “quality” in corporate credit markets. Traditional ratings can reflect default risk, but they do not fully explain total returns and excess returns. In an environment of increased AI-related financing and rising real rates, highly rated bonds are under pressure because new supply is concentrated in these ratings, duration is longer, and spread cushions are thinner. By contrast, slightly lower-rated assets with still-solid fundamentals and higher coupons, such as BBB and B-rated credits, have performed better. Goldman Sachs therefore shifts the allocation focus away from simply pursuing the highest ratings toward an integrated assessment of supply technicals, duration, spread income, and issuer fundamentals.

Core views

First, Goldman Sachs prefers BBB over AA and A in both USD and EUR investment-grade bonds. BBB offers higher spread income and is less affected by AI-related highly rated issuance. Second, USD high yield is adjusted from the previous overweight BB and underweight B stance to neutral on BB and overweight B, while CCC is downgraded from neutral to underweight; BB faces ongoing supply pressure from AI project financing such as data centers, while CCC has higher dispersion and single-name risk. Third, EUR high yield maintains an overweight BB, neutral B, and underweight CCC stance. Fourth, IG and HY allocations in both USD and EUR markets are adjusted to neutral, as Goldman Sachs no longer sees a clear advantage in broadly overweighting IG. Fifth, it continues to modestly prefer USD credit over EUR credit and modestly prefer high-yield bonds over leveraged loans.

Analysis framework

The report uses cross-region, cross-rating, and cross-asset relative value analysis, combining year-to-date total and excess returns, rating-tiered issuance, spread and coupon cushions, duration, balance-sheet changes, sector composition, macro policy, and default and ratings migration forecasts. The focus is not on judging quality solely by ratings, but on assessing the supply pressure, interest-rate sensitivity, fundamental margin of safety, and carry behind each rating.

Methodology notes

• Relative valueRating-tier comparison

  Compare returns, spreads, and supply pressure across rating cohorts within the same credit market

  By comparing total returns and excess returns across AA, A, BBB and BB, B, CCC, the framework identifies rating downshift ranges that can add spread income without excessively increasing credit risk.

• Market technicalsSupply technicals analysis

  The impact of issuance volume and its rating structure on secondary-market performance

  AI infrastructure and data-center financing are concentrating supply in highly rated investment-grade bonds and BB-rated high-yield bonds, with new bonds absorbing capital and creating relative performance headwinds.

• Interest-rate riskDuration and spread cushion analysis

  Measure the impact of rising rates on total returns across rating cohorts

  Highly rated bonds typically have longer duration and thinner spreads, making them less able to withstand rising Treasury yields; the higher coupons on BBB and B-rated bonds can provide stronger return cushions.

• FundamentalsSector and balance-sheet analysis

  Assess rating quality by combining sector changes and issuer leverage capacity

  Some highly rated technology companies have low balance-sheet leverage and may increase debt issuance and capital allocation in the future; the software sector is becoming more differentiated due to AI, requiring distinctions among infrastructure, development platforms, traditional application software, and SaaS issuers.

• Cross-asset allocationBond versus leveraged loan comparison

  Compare credit quality, sector exposure, buyer base, and yield differences

  Leveraged loans have higher software exposure and a larger share of lower-rated borrowers, while their buyer base is concentrated in rating-sensitive CLOs; at the same time, the extra yield of floating-rate loans relative to fixed-rate high-yield bonds has narrowed significantly.

Asset mapping & comparison

Structured mapping from thesis to named assets (strengths, weaknesses, peers, risks).

• USD investment-grade corporate bonds

  Core relative value market, modestly better than EUR credit

  Strengths

  Economic fundamentals are relatively more supportive, BBB spread income is higher, and market liquidity is better.

  Weaknesses

  Highly rated technology and AI-related issuance is large, duration is longer, and sensitivity to rising real rates is high.

  Comparison

  Prefer BBB within ratings, with reduced exposure to AA and A; maintain a neutral allocation overall versus USD high-yield bonds.

  Risks

  Continued rise in U.S. Treasury yields, AI financing exceeding expectations, and highly rated companies increasing leverage.

• EUR investment-grade corporate bonds

  Rating allocation shifts toward a more positive BBB tilt

  Strengths

  Euro area growth has been more resilient than expected, and BBB returns have led year-to-date.

  Weaknesses

  The mix of growth, inflation, and monetary policy remains more challenging than in the USD market, and European natural gas prices face upside risk.

  Comparison

  Overweight BBB, neutral on A, and underweight AA; regionally slightly less attractive than USD credit.

  Risks

  Rising energy prices, escalation of geopolitical conflicts, further ECB rate hikes, and faster AI-related supply.

• USD high-yield corporate bonds

  Neutral allocation versus investment-grade bonds, but tilted toward B within ratings

  Strengths

  B-rated coupons and spread cushions are higher, and recent excess and total returns have led.

  Weaknesses

  BB faces supply pressure from data-center project financing, while CCC has high dispersion and single-name risk.

  Comparison

  Overweight B, neutral on BB, and underweight CCC; has a modest advantage over leveraged loans.

  Risks

  Further acceleration of AI-related issuance in 2027, rising default rates, and credit differentiation in the software sector.

• EUR high-yield corporate bonds

  Maintains the existing rating allocation

  Strengths

  BB and B returns are close, and BB still offers a good balance between quality and income.

  Weaknesses

  The EUR CCC market is smaller and has significantly lagged, while the regional macro environment is more complex.

  Comparison

  Overweight BB, neutral on B, and underweight CCC; maintain a neutral allocation versus EUR investment-grade bonds.

  Risks

  Slower European growth, energy shocks, rising default rates, and insufficient market liquidity.

• USD and EUR leveraged loans

  Modestly underweight relative to high-yield bonds

  Strengths

  Floating-rate structures can benefit in a rate-hiking environment, and BB-rated loan returns are stable.

  Weaknesses

  Higher exposure to the software sector, lower overall credit quality, and a buyer base heavily dependent on rating-sensitive CLOs.

  Comparison

  High-yield bonds and loans have had similar year-to-date returns, but loans’ extra yield has narrowed sharply, making bonds more attractive.

  Risks

  AI disruption in the software sector, increased refinancing needs, falling CCC prices, and contraction in CLO demand during risk-off periods.

Key data

• USD investment-grade bond rating returnsBBB excess return 0.74%, total return -0.07%; A excess return 0.32%, total return -0.56%; AA excess return -0.62%, total return -1.84%From the start of 2026 to the report date, BBB significantly outperformed higher-rated cohorts.
• Initial spread cushion in USD investment-grade bondsBBB at 97bp, A at 64bp, AA at 48bpHigher spread income helped BBB cushion the roughly 50bp rise in 10-year U.S. Treasury yields.
• Share of highly rated USD investment-grade bond supplyAAA and AA account for 23% of year-to-date USD investment-grade issuanceThe highest share since 2016, reflecting concentrated financing by mega-cap technology companies.
• EUR investment-grade bond excess returnsBBB at 0.88%, A at 0.76%, AA at 0.38%BBB also leads, prompting Goldman Sachs to increase its tendency to move down in ratings within EUR investment-grade bonds.
• USD high-yield bond rating returnsB excess return 2.29%, total return 3.02%; BB excess return 1.82%, total return 2.34%; CCC excess return 1.13%, total return 1.89%B-rated bonds performed best, BB was affected by supply pressure, and CCC carries the highest single-name risk.
• BB share of USD high-yield bond supply61%This is the BB-rated share of year-to-date USD high-yield issuance, with data-center project financing the main driver.
• Software sector weightUSD B-rated bonds 7.5%, BB-rated bonds 2.4%, CCC-rated bonds 4.9%Software credit spreads have modestly recovered or stabilized, but internal sector differences remain large.
• Leveraged loan rating returnsUSD: BB 3.5%, B 2.5%, CCC -3.4%; Europe: BB 3.4%, B 2.4%, CCC -0.4%Total returns from the start of 2026 to the report date show the loan market still clearly prefers higher-rated borrowers.
• Yield difference between loans and bondsUSD B-rated leveraged loans provide 73bp of additional yield over B-rated high-yield bondsWell below the peak of about 270bp in September 2024, indicating that loans’ relative carry advantage has narrowed.
• Full-year 2026 issuance forecastsUSD IG $2,100bn, USD HY $400bn; EUR IG €850bn, EUR HY €125bnLarge new supply is an important constraint on rating and regional allocation.
• Full-year 2026 default-rate forecastsUSD HY 4.0%, USD leveraged loans 4.75%, EUR HY 5.0%, EUR leveraged loans 4.0%All are issuer-weighted trailing 12-month default-rate forecasts.

Impact & implications

Investors should not equate the highest ratings directly with the best risk-adjusted returns. In the current environment, concentrated supply and duration risk may keep AA and some BB bonds lagging, while BBB and B-rated bonds with fundamental resilience and higher coupons are more attractive. Portfolio construction should moderately move down in ratings, but not mechanically chase high spreads: CCC and software issuers more exposed to AI disruption still require rigorous single-name selection. Regionally, a modest preference for USD credit can be retained; at the asset-class level, maintain neutrality between IG and HY while modestly preferring high-yield bonds over leveraged loans.

Risks

• AI- and data-center-related financing may grow more than expected, further weighing on highly rated investment-grade bonds and BB-rated high-yield bonds.
• U.S. real rates or long-term Treasury yields may continue to rise, creating greater total-return pressure on long-duration, highly rated credit assets.
• An escalation of Middle East conflicts could push up Brent crude and European natural gas prices, weakening European growth and widening credit spreads.
• The software sector is highly differentiated by AI impact, and traditional application software and SaaS issuers may face budget pressure and refinancing risk.
• The CCC cohort has high dispersion, liquidity risk, and issuer-specific risk; higher spreads may not be sufficient to compensate for loss risk.
• Leveraged loan buyers are concentrated in CLOs, and in risk-off phases rating constraints may amplify technical pressure.
• Increased cross-border issuance blurs regional boundaries between USD and EUR markets, and traditional regional allocation relationships may become less effective.

What to watch

• AI-related bond issuance volumes and rating distribution in the second half of 2026 and in 2027.
• Whether the share of AAA and AA issuance in USD investment-grade bonds continues to exceed historical levels.
• The BB supply share in USD high-yield bonds and the pace of data-center project financing.
• 10-year U.S. Treasury yields, real rates, and the Federal Reserve policy path.
• ECB rate hikes, euro area growth resilience, and European natural gas prices.
• Whether BBB and B-rated bond spreads can still provide sufficient coupon cushions.
• Software credit spreads, refinancing needs, and performance divergence between infrastructure software and traditional SaaS.
• Default rates and rating migration trends in USD and EUR high-yield bonds and leveraged loans.
• CLO issuance, refinancing activity, and their impact on leveraged loan demand.