Photo Leonardo Basile © Eurizon

By Leonardo Basile, Portfolio Manager at Eurizon

European high-yield bonds still offer attractive yields with limited duration risk. Yields are high by historical standards, the asset class is relatively insensitive to interest-rate moves, and default rates are expected to stay low.

With considerable uncertainty over the future path of inflation and policy rates, this combination of current yield and limited duration risk is particularly valuable. Rising funding costs may well put pressure on the weakest issuers, but on the whole the market is differentiating effectively between borrowers. For active investors, this creates opportunities to invest selectively in issuers whose refinancing risks are more fully priced in.

Tight spreads, but carry remains attractive

Although spreads are relatively tight, overall yields on European high-yield bonds remain high enough to provide some cushion against volatility and spread widening. Higher yields also continue to attract inflows, which supports the market. As long as economic growth holds up and defaults remain low, the yield premium over investment-grade bonds of similar maturity remains compelling. This is especially true at the short end of the curve, where investors can capture a meaningful yield pickup without taking on substantial duration risk.

We believe the sweet spot lies in a selective mix of short-dated BB bonds and higher-quality B-rated issuers with clear refinancing prospects. Short-dated BB bonds offer attractive risk-adjusted returns, while some B-rated issuers can provide additional carry, provided their fundamentals are improving and their maturity profiles are well managed. At the same time, higher risk-free rates have made it possible to improve a portfolio’s credit quality without giving up much yield.

Choosing issuers and sectors carefully

Selectivity remains key at the issuer level. We favor companies with strong liquidity, positive cash flow, a clear maturity schedule and proven access to capital markets, demonstrated for example by recent bond issues or successful refinancings. By contrast, caution is warranted with highly leveraged companies facing persistent margin pressure or significant refinancing needs.

At the sector level, the gap is widening. Infrastructure, defense and certain industrial segments are benefiting from sustained public spending and greater revenue visibility. More cyclical sectors, on the other hand, continue to contend with weak demand and uncertainty over global trade. Higher energy prices are weighing on energy-intensive industries, including parts of the glass packaging sector and some airlines, while real estate issuers remain under pressure from higher interest rates.

Short duration as a complement to investment grade

Short-duration high-yield bonds can be particularly attractive as a higher-yielding complement to investment-grade holdings. Within a high-yield allocation, they can also serve as a more defensive position, being less sensitive to interest-rate swings and spread volatility.

Given the uncertainty surrounding inflation, monetary policy and geopolitics, we believe a short-duration high-yield strategy offers a good balance between return and risk control. With spreads already relatively tight, investors should rely primarily on current carry rather than count on significant further spread tightening. If inflation proves sticky and yields keep rising, the shorter duration profile should help limit the downside. In a recession, with credit spreads widening, short-duration high-yield bonds should outperform broader high-yield strategies, thanks to their shorter spread duration and greater visibility on repayment. If default risk were to rise materially, however, it would be preferable to move into higher-quality investment-grade securities.

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