A favourable environment for high yield bonds

High yield bonds have often been viewed with caution by investors yet have frequently generated returns above those of government or investment grade bonds. With attractive yields on offer, Sid Chhabra, head of European High Yield, Securitized Credit and CLO Management, looks at why now is a good time to invest.

The case for high yield

Over the medium to long term, the asset class has consistently delivered 300-400bps of excess returns over government bonds. It has also had an impressive run relative to corporate investment grade bonds, delivering ~300bps of excess returns.

Today, with higher expected rates, a broadly positive backdrop for growth, and relatively lower defaults, the environment is favourable for strong return generation over the coming years.

A key point is that high yield has benefited from a continued improvement in quality over the last decade, as several companies within the index are at lower leverage points. This is reflected in the ratings mix, with a growing proportion of BB-rated issuers.

High yield bonds in today’s market

While spreads and valuations have tightened of late, the benefit of higher base rates and a backdrop of growth means we expect to see high single-digit returns over the next 12 months.

This is partly driven by an anticipated increase in supply. M&A activity and leveraged buyout (LBO) volumes are likely to pick up, and this should drive higher issuance levels compared to the subdued supply of the last two years. Additionally, some high yield issuers still need to refinance their debt. All in all, we expect the supply picture to be healthy over the coming year.

Furthermore, there is significant dispersion in trading levels, among individual securities and across sectors. For active, fundamental credit investors, this creates a fertile environment for generating alpha. The backdrop of stable economic growth should help keep default rates relatively low. We expect base case defaults to be closer to 2.0-2.5%, many of them coming from well-known, idiosyncratic stories.

Overall, we anticipate 2025 to be an active year for the high yield market, driven by increased supply and significant dispersion. The asset class’s attractive carry – supported by elevated base rates and spreads in the 300-350bps range – positions it for potentially high single-digit returns over the year.

The intersection of high yield and private credit

There has been a notable growth in private credit recently, which we believe is a boon for our strategy in terms of how it intersects with the high yield market. While both focus on non-investment grade borrowers, they differ in structure, access, and use. The growth and development of the private credit asset class is important for several reasons:

1. It gives corporate issuers an additional channel to source financing and credit, rather than solely relying on the public channels of high yield bonds or syndicated loans.
2. Private credit can offer solutions that typically give sponsors financing at higher leverage points, many times at six turns or greater leverage versus the high yield market that is, on average, hovering around three turns of leverage.

The growth of the private credit and loan markets have created a positive dynamic for the public high yield market. Smaller and mid-scale issuers, often owned by private equity sponsors, have increasingly turned to private credit as an alternative channel for financing. This shift has enabled issuers to secure financing at higher leverage, often bypassing the high yield bond market. As a result, high yield now exhibits lower leverage overall, effectively evolving into a higher-quality segment within the broader leveraged finance space. As most of the index is BB-rated, the development and growth of private credit has been a positive technical for high yield.

Select opportunities

Given the current material dispersion between sectors, we believe the following sectors offer good opportunities:

• Banks: banks continue to report strong earnings which are translating into improved profitability metrics. On a spread and carry basis, the sector is still trading wide, so there are opportunities particularly within financial services.
• Energy: although a cyclical sector, energy is offering attractive total return opportunities, particularly in the new issue market. A significant amount of refinancing activity and corporate actions is creating compelling single name investment opportunities.
• Telecoms: the sector benefits from generally stable and growing revenues. Within the sector, we are focused on names that have an asset-rich base of infrastructure and an advantage beyond solely their earnings.

We are also cautious on certain sectors:

• Real estate: issuers are grappling with higher rates and financing that was extended at stretched valuations. Over the past 12-24 months, the sector has experienced heightened stress. However, with lower rates – particularly in Europe – we’ve identified more interesting opportunities within the sector to capture value.
• European autos: there is lower profitability coming from China for many European original equipment manufacturers (OEMs). This, coupled with lower EV sales, is beginning to negatively impact earning. Recently, there has been growing attention on the sector’s struggles, including shrinking margins and declining profitability among both European OEMs and their suppliers. We expect to remain cautious on this sector given the increased newsflow on tariffs, which will likely translate into more pressure on margins.

Why BlueBay for high yield?

Our large and experienced team has a wealth of experience over 20-plus years. We manage nearly USD20 billion in assets within the leveraged finance cohort, across a variety of vehicles.

We have followed issuers’ earnings and performance through many cycles. In our view, this gives us an edge, as we know issuers in the market well and understand their dynamics.

We are also a key counterparty to sponsors and dealers. This connectivity with the market, alongside our team size and experience, enable us to express credit views in portfolio construction, and should help generate returns for clients.