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Key points:
- With attractive yields and a low duration profile, high yield can present potentially compelling opportunities for investors.
- We believe Europe’s high-yield market is particularly attractive, given its ability to offer high yields but low duration.
- However, spreads remain tight, and the geopolitical and market backdrop still looks uncertain. Active investors may be able to exploit inefficiencies while managing risks.
With 2025 well underway, we believe high-yield fixed income remains an attractive asset class for investors. While greater volatility and uncertainty continue to characterise the new macro regime, it is also an investment landscape from which active high-yield investors can benefit, given the potential for increased dispersion across regions, sectors and issuers.
For us, the standout region for high-yield investors is Europe — a market that is significantly larger, more diverse and higher quality than it has been in the past — and one that we believe can offer attractive alpha opportunities for active investors.
Why Europe for high yield?
1. Yields are attractive
While spread levels in European high-yield bond markets are below historical averages — even if somewhat wider than US levels — yields remain very attractive, creating a compelling offering for investors. It’s worth emphasising that over time, yields are typically a key driver of investment returns, with our research suggesting that they are a good predictor of long-term forward returns1.
Figure 1
2. Duration is low, mitigating potential risks associated with interest-rate volatility.
The global high-yield market has a short duration profile, with European high yield in particular benefiting from a shorter duration than the global high-yield market — mitigating the inherent interest-rate risk relative to longer-duration portfolios. In our view, this is a crucial consideration for high-yield investors as the direction of rates continues to be a major variable for bond markets. Against a backdrop of continued divergence between the trajectories of national economies, we believe fiscal policy and tariffs are likely to dominate markets, as policymakers tackle the growth/inflation trade-off in different ways. We believe further bouts of uncertainty driven by elevated rate volatility may translate into greater volatility in risk-asset valuations and accelerate dispersion across regions, sectors and issuers — offering active managers exciting opportunities to manage risk and generate alpha.
Figure 2
3. The European high-yield market stands out for its higher quality profile, and we do not see a default cycle on the horizon.
In addition to being much larger than it was 10 – 20 years ago and offering investors a significantly wider opportunity set, today’s European high-yield market has seen a steady increase in quality. Currently, over two-thirds of the market, as measured by the ICE BofA Euro High Yield Constrained Index, is rated BB, and only approximately 6.5% is rated CCC and below2. When we combine the higher quality composition of the local market relative to past cycles with the fact that corporate fundamentals remain robust, we do not believe a full-scale default cycle is on the horizon. Instead, we think European default rates are likely to stay close to their long-term averages over the next 12 months. We’re also seeing the high-yield market be more disciplined than in the past — many deals that have come to market haven’t been funded in the high-yield market but have instead gone to other markets, such as private credit.
Where are the risks and opportunities in 2025?
While we believe European high-yield valuations look attractive relative to the US, tight spreads call for investors to be prudent decision-makers. One of our overarching beliefs is that the high-yield market is highly inefficient at pricing default risk — implying the need for deep, fundamental research. In 2025 and beyond, we’re watching the following themes, which we think present active investors with both risks and opportunities.
Europe could face US tariffs…but not all sectors and issuers will be affected equally
The geopolitical backdrop remains complex and uncertain. We think investors need to reposition for potentially greater dispersion across sectors and issuers, particularly in the context of the threats that US President Donald Trump’s planned tariffs could pose. This is where we believe sector- and issuer-level analysis plays a key role. The European high-yield market is typically very domestically focused, with large sectors such as utilities and services supplying their local regions. We believe certain sectors, such as the automotive and basic industry sectors, are more exposed to tariff risk, meaning caution is warranted. On the other hand, sectors where there is a lower level of competition, such as supermarkets, may find themselves in a stronger position to pass through to end consumers the additional costs from tariffs. This could mean that certain issuers are likely to see only a limited impact on margins. In our view, this makes it even more important to prioritise companies with sustainable competitive advantages.
Another DeepSeek-level event could shake market conviction in AI…making it prudent to avoid sectors with increased capacity
AI is, of course, enabling an exciting new phase in the ongoing technological revolution, with potentially promising new applications across society. But predicting who will be the winners and losers of the AI boom is far from straightforward and there will inevitably be instances of misdirected capital. We’re wary about the significant levels of above-trend investment and capex and the resulting potential for a bubble to form given the enormous level of borrowing seen in the industry. As such, we remain doubtful about the prospects for high-yield companies with high exposure to the AI theme, for example, utility companies that are providing the underlying infrastructure required to expand AI capabilities. However, within technology more broadly, we see a number of opportunities in payment providers and software services companies with strong competitive advantages like the high expense of changing suppliers.
Market volatility could continue and spreads could widen… giving high-yield investors the opportunity to potentially generate alpha from valuation opportunities
While high-yield bonds can continue to offer attractive coupon payments, tight spreads reduce the scope for capital appreciation. However, if volatility in fixed income markets continues, we may see a return to spread dispersion in the market. In our view, this may provide the potential for active investors to generate alpha from valuation opportunities. In this environment, we think it’s possible for active managers to add value over benchmark indices through bottom-up, fundamental credit selection.
How high-yield investors can benefit from volatility
We believe the environment for high-yield bonds will present attractive income opportunities for investors over the next 12 months, with active managers potentially 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.
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1Sources: Wellington Management. Average of rolling periods from January 1985 to June 2023. | 2ICE Data Indices, LLC “ICEDATA”. Data as of 28 February 2025.
