Capital Group: The Strategic Value of High-Yield Allocation
5 SEPT, 2025
High-yield bonds have grown more resilient with stronger fundamentals and tighter spreads, offering attractive opportunities for selective investors.
By Edward Harrold, Investment Director at Capital Group
Over the past five years, financial markets have faced an extraordinarily turbulent period, marked by severe shocks. These include the global pandemic in 2020, aggressive interest rate hikes by central banks in 2022, geopolitical tensions following the outbreak of the Russia-Ukraine conflict in February 2022, the banking crisis in the United States in 2023, and the imposition of tariffs in 2025. Despite these significant turbulences, the high-yield (HY) market has demonstrated remarkable resilience and has established itself as the bond segment with the strongest performance.
There are reasons to believe that structural changes in the high-yield market have made it more resilient to shocks; moreover, it appears well-positioned to continue generating solid returns in the future. These strengths also partly explain why spreads are trading at relatively tight levels compared with long-term historical averages and may continue to do so even in the absence of external shocks.
The High-Yield Market Is No Longer “Junk”
The composition of the high-yield market has undergone a significant transformation over the past two decades. Since the global financial crisis, leverage has shifted from the private sector—companies and households—to the public sector, resulting in a much more disciplined approach to corporate debt. Consequently, the quality of the companies included in the HY index has improved significantly. While the BB segment—the highest-quality portion of HY—now represents over 50% of the index, the B and CCC categories have declined over the past 15 years.
At the same time, secured bonds have reached a record high, representing roughly 34% of the market. This structural change, driven by issuers seeking to reduce refinancing costs through collateral—especially for lower-rated bonds—has contributed to improved credit quality and greater protections for investors.
Improvements in both quality and structure explain not only why spreads have traded below historical averages in recent years, but also why the HY market has been resilient during periods of stress. In today’s high-yield market, investors take on lower credit risk while achieving solid returns.
Current Conditions Favor HY Spreads
Companies are in strong financial health with solid fundamentals. While sales and EBITDA growth have slowed (though both remain positive), total debt has remained largely unchanged. This means that both leverage ratios and interest coverage ratios are well-positioned to weather a potential economic slowdown and absorb some of the expected cost increases stemming from current U.S. trade policy. While coverage ratios have declined from post-COVID multi-decade highs due to higher refinancing costs, they have recently stabilized and remain near post-financial-crisis averages. Coverage levels are lower in the leveraged loan market.
Additionally, HY issuance has been fairly subdued since the beginning of the year, below the average levels seen over the past four years. This trend reflects issuers’ cautious approach in light of rising funding costs. Looking ahead, the outlook for HY issuance remains favorable. A substantial portion of 2025 and 2026 maturities has already been addressed, and it is estimated that less than 3% of the HY market will need refinancing by year-end. The limited refinancing need points to a relatively stable issuance environment in the short term, reducing pressure on companies that don’t have to access debt markets at less favorable terms. With U.S. benchmark rates in the mid-cycle of easing, companies have significant leeway to wait for gradual rate normalization and manage the maturity wall in 2028 and beyond.
Capital Raising Trends Shift Toward Private Credit
Over the past decade, there has been a clear shift in corporate capital-raising preferences, with many companies favoring private credit and financing over the traditional HY market. This preference stems from the ability to negotiate customized deals with private credit managers and banks, better suited to their specific needs. Consequently, while the overall size of the HY market has remained largely unchanged over the past ten years, private credit and leveraged loan markets have grown exponentially, surpassing HY.
This trend is particularly evident in leveraged buyout (LBO) transactions, which historically relied heavily on HY bonds. Over the past 20 years, however, there has been a strong shift toward leveraged loans. Factors driving this change include flexibility from “covenant-lite” structures, competitive pricing, and collateral to mitigate risk. In recent years, private credit has emerged as the top choice for most LBO transactions.
The shift toward more tailored financing options is likely to continue, representing a strong technical advantage for the HY market as demand exceeds supply. Conversely, this dynamic should support the tightening of spreads.
Opportunities for Active Management
Sectors such as REITs and brokers can offer significant value due to solid cash flows and earnings predictability, even during potential economic slowdowns. REITs benefit from stable rental income and property appreciation, while brokers gain from trading volume growth and market activity. Conversely, sectors such as capital goods, building materials, and automotive may be more exposed due to their cyclical nature and vulnerability to escalating trade barriers between countries.
These more vulnerable sectors often face higher volatility and capital-intensive operations, which can challenge financial stability during slowdowns. Therefore, selectivity and active management are crucial to extract value in a market where valuations are generally low, but some companies and sectors are likely to outperform. Today, selectivity is more important than ever given uncertainty around if, where, and when tariffs will be applied.
What Should Investors Expect Going Forward?
In the absence of an external shock and considering the HY market’s resilience, along with solid fundamentals and favorable technicals, spreads could remain below historical averages for an extended period. This scenario is not unusual. Spreads remained tight for long periods in the 1990s and 2000s. Over the past 15 years, when HY spreads were tighter than long-term historical averages, the US Corporate High Yield 2% Issuer Capped Index outperformed the US Aggregate Index by over 50% on average over the following 12 months. As the chart shows, in these periods, the two indices delivered 12-month returns of 4% (US HY) and 2.5% (US Aggregate).
Moreover, investors can benefit from a more resilient asset class. The gradual improvement in quality has made the U.S. HY market significantly more resilient during periods of stress compared with the past. This resilience was evident after the recent downturn following Liberation Day in early April. Unlike past periods, such as June–December 2008 (when U.S. equities and HY fell in tandem by 28.5% and 25.1%, respectively), this year the U.S. HY decline was a fraction of equities (-15% for the S&P 500 versus -1.8% for U.S. HY from January 1 to April 8, 2025).
