High-yield bond investing in 2025: the year of the coupon

As 2025 gets underway, we believe high-yield fixed income remains an attractive asset class for investors because of its high income potential amid a supportive environment for credit fundamentals. On the whole, corporate earnings for high-yield companies are still robust across the market. We also do not see significant signs of a broader slowdown in that positive trajectory for a wide variety of issuers in the market. That said, the tight credit spreads in high-yield bond markets suggest the need for greater caution and a more active approach.

The European advantage

We think this year may bring greater regional divergence across markets, which active investors can seek to exploit. In our view, European high-yield bonds in particular offer attractive relative value. When we combine robust corporate fundamentals with the higher-quality composition of the local market, we do not see a full-scale default cycle on the horizon. Instead, we believe default rates are likely to remain low, at 2% – 3% over the next 12 months. From a valuation perspective, we acknowledge that spread levels in European high-yield bond markets are below historical averages — even if somewhat wider than US levels — and therefore imply less room for tightening from here. There is also the risk of sudden spread widening, particularly in more vulnerable market segments.

Taking a more holistic view, however, we believe that European high yield scores well in terms of yield metrics. Investors are still rewarded with a handsome coupon — an important metric given that over the past 20 years, income has tended to provide around 90% of the returns achieved by the asset class.¹ At the same time, we think investors need to reposition for potentially greater dispersion between sectors and issuers, particularly in the context of a weakening European economy and the threat that US President Donald Trump’s planned tariffs could pose.

Implications for investors

Given this backdrop, we believe investors should focus on bottom-up analysis and consider companies on an issuer-by-issuer basis — looking for high-conviction names with strong competitive advantages relative to their peers, which increase their potential to outperform over longer time horizons. We think investors should not assume that the low degree of sector dispersion — particularly at current spread levels — will endure. We would urge caution in relation to sectors experiencing a rapid build-up in capacity, such as the AI-related technology and renewable energy sectors, as this could lead to oversupply and, eventually, defaults. Energy is a sector we have become increasingly concerned about giventhe recent volatility in commodity prices. Most producers do not have differentiating features that can help them stave off increased competition in the event of a downturn.

Many energy producers in the high-yield universe are well hedged, but if oil prices move below US$60 a barrel, we would become more concerned about the sector’s credit metrics.

In our view, the primary risk to high-yield markets from here would be a pivot from the current soft-landing narrative towards a “false-landing” scenario where the global economy picks up at speed rather than continues its slowdown. In this scenario, inflation would likely reaccelerate, meaning central banks would need to move to a rate-hiking strategy. We therefore consider the direction of interest rates to be a major variable for the high-yield bond market. That said, the duration of the high-yield market is near record lows, at below three years, which mitigates the inherent interest-rate risk relative to longer-duration portfolios. Further bouts of volatility driven by changes in interest-rate expectations may also offer active managers exciting opportunities to generate alpha.

At the same time, it is important to maintain a long-term perspective. In our opinion, investing in high yield is a marathon not a sprint. We think that investors who combine a structural, long-term approach to high-yield bond investing with a fundamental research-based lens are well positioned to make the most of the asset class regardless of cyclical ups and downs.

Bottom line

We believe the environment for high-yield bonds will present attractive income opportunities for investors over the next 12 months, with active managers best positioned to benefit if we see a return to interest-rate volatility. We favour European over US high yield given its greater income potential and higher-quality bias. From a longer-term perspective, we view high-yield investments as continuing to play a crucial role in diversifying and enhancing bond portfolios.

¹Using index data for the ICE BofA Euro High Yield Constrained Index. Sources: ICE, Wellington Management | Data from 31 December 2004 – 31 December 2024.