Certain uncertainty: Income opportunities in high yield bonds
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Article Type
BondTalk
Topic
High Yield
Published
March 27, 2025
Read time
5 mins
Authors
Thomas Hanson, CFA
Mark Benbow
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From tariff threats and political tensions to waning economic outlooks, investors today are facing increasing uncertainty. As the worries snowballed, the uncertainty ultimately became too much for investors to bear with sentiment turning negative in March. Equities declined and the high yield market experienced its first notable sell-off in some time with high yield credit spreads widening off historically tight levels. 

 

While we view the recent spread widening as a healthy correction, all things considered, it is natural for investors to worry about volatility. How should investors navigate this uncertainty, and what does it mean for the path ahead for high yield bonds?

 

Navigating uncertainty: Look for income opportunities 

 

As we look ahead, the only thing we can say with full certainty is that markets will continue to face uncertainty in 2025. However, this uncertainty can also create opportunities. While it might be tempting to de-risk and rotate out of high yield bonds in fear of spread widening, we believe there are various factors favoring high yield bonds now. 

 

For income-oriented investors, high yield bonds can continue to provide steady carry via the income from coupon payments. As rates shifted higher in recent years, coupon rates on newly issued bonds continued to climb higher, offering income opportunities rarely seen in recent years. Provided the company continues to pay its coupon payments, this income can help provide some certainty in uncertain times.  However, an active approach to high yield coupled with in-depth credit research, is imperative to support the bottom-up company and selection process. 

 

Market volatility is likely to persist and it’s possible that spreads could continue to widen. However, it is important to remember that income tends to drive returns over the long term. As shown in Exhibit 1, income has been the largest driver of fixed income total returns for the high yield index over the long term. The income, or carry, from coupons can also provide a buffer against spread widening and price movements. While prices can be volatile, income has historically been a steady driver of returns over time.  In addition, the high breakeven on high yield (yield divided by duration) can act as a significant buffer to help protect total returns.

 

Exhibit 1: Income, not price, is historically the main driver of high yield bond returns
Cumulative price and income return of the ICE BofA Global High Yield Index

Source: Bloomberg and ICE BofA. As of 28 February 2025. Reflects the price and income return for the ICE BofA Global High Yield Constrained index. Past performance does not predict future returns. It is not possible to invest directly in an index. All investments contain risk and may lose value.

 

Bonds are still back, offering enhanced yield potential over equities

 

Not only do high yield bonds offer enhanced coupon rates and yield potential relative to many other fixed income investments, but high yield bonds also offer enhanced yield potential relative to equities. As shown in Exhibit 2, the yield on the ICE BofA US High Yield Index is now substantially higher than the earnings yield of the S&P Index.

 

For investors concerned about downside risk in equities, high yield bonds are a natural place to look. Allocating a portion of the portfolio from equities to bonds can provide interesting opportunities to de-risk the portfolio and generate more of the return from carry (income). In addition to adding income via high yield bonds, allocating to high yield bonds doesn’t mean sacrificing returns; historically high yield bonds have delivered equity-like returns over the long term with lower volatility. 

 

Exhibit 2: Bonds are back, offering enhanced yield potential vs. equities 
US high yield to maturity vs. US equity earnings yield

Source: ICE BofA, S&P and Bloomberg. Updated as of 28 February 2025. Based on monthly index data. It is not possible to invest directly in an index. All investments contain risk and may lose value.

 

Volatility can create opportunities

 

Times like these also remind us that volatility can create opportunities. Generally, active asset managers welcome periods of volatility. These environments can create dislocations and expose mispriced bonds. As high yield spreads widen, this valuation reset can present attractive entry points for investors to further increase their high yield bond exposure.


 
However, it is incredibly challenging to predict when the asset class could experience sustained spread widening. And when spreads do widen, this could be short-lived as buyers could quickly step in to buy the dip. While it might be tempting to wait for wider spreads to present entry points, some investors may find that it is better to be paid to be in the game than sit on the sidelines. A maximum overweight allocation to the asset class may not be justified at this time given spread levels, but there’s a case to be made to have some high yield bond exposure.  Although markets may be volatile, investors can continue to benefit from income and clip a coupon from high yield bonds, in an effort to provide some much-needed certainty in these uncertain times.

 

Disclosures

Authors

Thomas Hanson, CFA
Portfolio Manager
Thomas Hanson, CFA, portfolio manager, specialises in high yield bonds and is responsible for co-managing our global high yield strategies.
View profile
Mark Benbow
Portfolio Manager
Mark Benbow, portfolio manager, specialises in high yield bonds and is responsible for co-managing our global high yield strategies.
View profile
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