The label “junk bonds” has been around long enough to subtly influence how many investors think about the high yield market – as something inherently reckless, a place you go when you are willing to gamble. After 26 years in credit markets, 13 of them focused specifically on high yield, I find that characterisation increasingly frustrating and substantially wrong.
The reality is that high yield, approached with discipline and genuine selectivity, offers something uniquely valuable in the current environment: an income-based return in a world where relative certainty is hard to find, a natural inflation hedge through real yields, and a structural advantage that is often overlooked – the asset class simply does not have value traps in the way equities do.
Dated capital either gets repaid or it does not. If it looks cheap, you will have the luxury of finding out in short order whether your analysis was correct or not. You do not need a catalyst or a re-rating for value to be realised; simply the passage of time and the discipline to avoid the losers.
The spread problem
In the current market, credit spreads across high yield are not where I would want them to be. The compensation investors are receiving for default risk, adjusted for fundamentals and excess spread, looks expensive on most metrics – and that was true even before the current geopolitical uncertainty added new layers of risk to the outlook.
Why haven’t spreads widened more? The honest answer is technical. For an extended period, demand for high yield paper has exceeded supply, and that imbalance has suppressed spread peaks even when the macro picture has deteriorated.
The market has also developed a habit – a somewhat Pavlovian one – of buying dips aggressively, having been rewarded for doing so through multiple cycles. That reflex works until it does not, and I think investors are underestimating the risk that the current situation proves more persistent than the quick, clean resolutions markets have grown accustomed to.
How to navigate tight spreads
When spreads are not compensating you adequately for risk, the response cannot simply be to exit the market. High yield still offers compelling starting yields, and the income argument remains powerful. Our approach has been to use that income as a buffer – constructing portfolios where the break-even, expressed as yield divided by duration, gives us substantial room to absorb spread widening before we are into negative total return territory.
A portfolio with a high average coupon and short duration is a fundamentally different proposition from a long-duration, lower-quality portfolio, even if both sit under the broad “high yield” label.
The quality and duration levers matter enormously here. If you are genuinely bearish on spreads and want to be maximally defensive, a short-duration, high-quality portfolio of double-B credits will protect you well – but you will give up significant carry versus benchmarks and peers while you wait, and that wait can be very long indeed. Our view is that you can take a measured degree of credit risk while staying short on duration, generating income returns that make the waiting period manageable and productive.
Geography and selectivity
One of the structural advantages of running a truly global high yield mandate is the freedom to find value where it actually exists, rather than where indices dictate it should be.
Approximately 60% of the global high yield market is US dollar-denominated, and most investors in the asset class are therefore heavily exposed to US high yield. We have chosen to be significantly underweight the US – not because the US macro picture is unattractive, but because US spreads simply do not reflect adequate compensation relative to fundamentals and leverage.
Instead, investors can find more compelling opportunities in European high yield, Nordic bonds, hard currency emerging market debt, and sterling high yield – a market that has traded cheap relative to peers for the best part of a decade and continues to offer genuine value for investors willing to do the bottom-up work.
Private credit and AI
Two structural shifts deserve serious attention from high yield investors. The first is private credit. Its growth has been extraordinary, but it has not yet been through a real credit cycle. Poor underwriting standards and loose lending practices do not announce themselves until conditions tighten – and when they do, the transmission mechanisms between private and public credit markets are real. Investors who cannot exit private credit positions will look for liquid proxies, and public high yield is an obvious candidate. We are watching this carefully.
The second is AI disruption. We have seen whole sectors sell off sharply when a new AI application threatens an established business model, sometimes with only a tenuous connection to the underlying fundamentals. That creates both risk and opportunity – but the asymmetry of getting it wrong in bond markets means caution is warranted. Preserving capital comes first.
High yield remains a compelling asset class. But it rewards rigour, not complacency.
