Two chief investment officers said they're eyeing a coming wave of credit downgrades in the lowest rung of investment-grade bonds. One executive called underwriting for that group 'a disaster.'

Anne Walsh, who oversees $182 billion as Guggenheim Partners' head of fixed income, said less than 25% of her portfolio is in corporate credit, a record low allocation.

Walsh is also concerned about potential volatility triggered by investors who haven't been big bond buyers in the past. If a downturn comes, Walsh doubts they'll hold their investments.

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Executives who oversee hundreds of billions are sounding alarm bells on a major chunk of the bond market.

The lowest rung of investment grade, BBB, makes up roughly half of the $5.3 trillion investment-grade market, the biggest share in history, per Morgan Stanley. It's a growing chunk of the market – the group has doubled in size over the last decade – and a growing concern. While the debt held by those firms is considered relatively safe and at low risk of default, the group's overall quality has declined over time, according to Nomura, based on BIS Quarterly Review data.

"There will be downgrades," Chris Gunster, chief investment officer of fixed income at Bank of America, said at a Philadelphia conference. "The credit underwriting is a disaster in the BBB space."

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Since that debt is already on the precipice of being labeled high-yield — or junk — it's especially vulnerable to any shift in market conditions. Whether that change is a simple slowdown or a full-blown recession, risks are mounting as the economic cycle pushes further into its later stages.

Speaking at the Fixed Income Leaders Summit on Thursday, Gunster said firms aren't getting paid enough to take on that risk, since the yield for the BBB index is at an all-time low.

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Fellow panelist Anne Walsh, who oversees $182 billion as Guggenheim Partners' head of fixed income, said "you could see an overwhelming amount of downgrades" in the BBB market.

She's also wary of covenant-lite loans, which lack the traditional requirements for companies who take such loans to maintain or beat certain financial benchmarks.

Walsh said these risky areas of the bond market could be exacerbated in a downturn by Asian investors "who historically weren't credit buyers." They may not be willing to hold their investments in a downgrade, "leading to a huge amount of volatility during a crisis moment."

Eyeing these problems, Guggenheim is looking for short-duration loans and is a big structured credit buyer, Walsh said. She's lowered the firm's corporate credit allocation to a record low, comprising less than a quarter of the firm's portfolio. The corporate credit investments the firm holds are "carefully selected" to perform through an economic cycle, Walsh said.

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