In his four-decade career managing bond portfolios, Scott Colbert has rarely felt compelled to make drastic strategic shifts. However, he notes that this is precisely such a moment. Colbert serves as the fixed-income chief at Commerce Bank in Clayton, Missouri, overseeing $28 billion in assets. He is not anticipating economic storm clouds — quite the opposite, he expects growth to accelerate in the coming months. The issue lies in the fact that corporate debt is currently priced at levels offering minimal margin for error, with potential returns no longer justifying the risks undertaken.

From AT&T (T.US), JPMorgan Chase (JPM.US) to Amazon (AMZN.US), bonds issued by U.S. blue-chip companies yield only 0.8 percentage points more than Treasuries — a premium that has nearly touched the multi-decade lows seen earlier this year. This means a spread widening of just about 12 basis points would be enough to erase an entire year's excess return over government debt. This is part of the reason Colbert has slashed his corporate credit exposure to its lowest level since 2012. Simultaneously, he has raised allocations to the safest corners of the fixed-income market — Treasuries, agency debt, and cash — to their highest point since 2005.

At 65 years old, Colbert has managed the $1.1 billion Commerce Bond Fund since 1994, making him the longest-tenured manager in his Morningstar category. He remarks: "Opportunities in the market are genuinely scarce. The compensation for the risk I take is the lowest I've seen in my career." This adjustment has yet to yield significant returns. Year-to-date, the broad Treasury index has declined roughly 0.1%, slightly underperforming corporate debt and the overall fixed-income market, as inflation and deficit concerns push long-term yields near two-decade highs. To ease pressure, Treasury Secretary Scott Bessent unexpectedly announced on Wednesday an increase in long-term debt buybacks. Nevertheless, Colbert remains patient — his fund has outperformed 94% of peers over the past 15 years.

He has been steadily reducing risk for some time. As of the latest data at end-June, corporate bonds in his mutual fund and separate accounts fell to 39%, down significantly from approximately 53% in 2021. Meanwhile, Treasury and cash holdings rose to 23% from under 16% five years ago. Additionally, the share of government-guaranteed mortgage-backed securities (MBS) has more than doubled during this period to 27%. This tilt toward higher-quality assets has lifted the portfolio's average credit rating from A+ to AA-, its highest level ever. This reallocation comes against a backdrop where investors, enticed by absolute yields rarely seen since the financial crisis and resilient economic momentum, have flocked to credit markets. These inflows have further compressed corporate bond spreads over Treasuries to near their tightest since 1997, even as tech companies flood the market with supply to fund artificial intelligence (AI) investments.

Colbert points out: "If there was ever a time to modestly reduce risk, it's now — because the yield you give up is minimal." Historically, Colbert's credit risk has been higher than the benchmark — the Bloomberg U.S. Aggregate Bond Index. Even after the reduction, his current corporate exposure remains about 15 percentage points above that Treasury-dominated benchmark. Therefore, this move is not a bet on an economic downturn but a risk management strategy. Colbert admits: "If the market truly collapses, I would suffer losses too. So I'm not expecting that scenario. It's just that, at the margin, I'm unwilling to take on as much risk as before."

Concerns Over an 'AI Bubble'

One of the key risks Colbert is monitoring is the stock market. The AI frenzy has driven the total market capitalization of U.S. equities to roughly $82 trillion, equivalent to over 250% of the nation's economic output — about 100 percentage points higher than at the peak of the internet bubble. Colbert does not believe the AI boom — which he calls a "bubble" — will burst anytime soon. However, he worries that any stock market volatility could impact consumer spending, which has been supported by rising household wealth.

Colbert, originally trained in nuclear engineering, entered the investment industry in 1986 when he was hired by Armco Steel, then one of America's largest steel producers, to manage bond investments for the company's pension fund. He recalls: "When I first arrived, they told me: 'We'll leave stocks to the smart folks in Chicago, New York, and London. But bonds — anyone can handle that.' I was that 'anyone.'" However, his timing was impeccable. Paul Volcker was then battling inflation, ushering in a decades-long bull market for bonds. In 1993, Colbert joined Commerce Bank and took over the Commerce Bond Fund the following year. Unlike some investors who bet on interest rate direction, he keeps the portfolio's duration (a measure of interest rate risk) close to the benchmark. Instead, he generates excess returns through spread products such as corporate bonds, MBS, and asset-backed securities.

This strategy has consistently delivered solid outperformance. Over the past 15 years, the fund has posted an average annual return of 2.5%, surpassing its benchmark. Colbert notes that the current environment reminds him of the late-1990s internet bubble era. Back then, after Federal Reserve Chair Alan Greenspan warned of "irrational exuberance" in 1996, the stock market briefly corrected before extending its rally for several more years. Colbert's conclusion: the lesson is that high valuations can persist far longer than investors expect, making it nearly impossible to time market turning points. Rather than betting on timing, it's wiser to reduce risk when the cost of adjustment is low. He states: "In times of plenty, I prefer to pull back a little. Don't get too greedy."