Fixed income investors are weighing a familiar set of risks – energy-driven inflation, high government borrowing, a difficult central bank backdrop. Yet credit spreads are tight, as if none of that mattered.
Starting yields, meanwhile, remain attractive, and that changes the investment equation. In the era of exceptionally low yields, investors often had to reach further into duration or credit risk to generate meaningful income. That trade-off is less necessary today. Higher-quality high yield can offer an attractive level of coupon income without pushing investors aggressively down the credit spectrum.
When we talk about higher-quality high yield, we are typically referring to the BB market. While some BB businesses tip towards becoming distressed credits over a long period of time due to structural industry shifts or management errors, others operate with a BB rather than a BBB rating by choice. These are the companies we favour – large, financially strong names that could easily qualify for a BBB rating, but which deliberately run with more leverage than a higher rating would allow in order to use that balance sheet capacity for activities such as shareholder returns, M&A or growth investment. These are businesses that can generate several billion dollars of cash flow and retain significant flexibility to cut dividends, capex or other discretionary spending if conditions deteriorate.
This combination of income and financial flexibility becomes especially useful when compared with other ways of accessing yield today. For example, longer-dated government bonds remain sensitive to shifts in inflation expectations, fiscal credibility and developments in other major sovereign markets.
High yield offers a different source of return. Duration is generally lower than in many other areas of fixed income, while the coupon still provides a steady source of income. That matters when rate expectations are moving quickly and markets are absorbing repeated geopolitical and policy shocks.
The economic backdrop has also been more supportive for high yield than many expected. Data in both the US and Europe has continued to surprise to the upside, while positive earnings momentum has helped support corporate fundamentals. In our view, that creates a favourable environment for higher-quality issuers, even if spreads remain range-bound.
This does not mean investors should be indiscriminate. With credit spreads tight, we see little reason to stretch into lower-quality credit simply to generate additional return. The opportunity is instead to focus on stronger, more defensive businesses and allow coupon income to do more of the work.
This is where we see the appeal of higher-quality high yield today. Investors do not necessarily need a large fall in government bond yields, significant further spread tightening or a move into the riskiest parts of the market to generate attractive income. In an uncertain environment, the combination of higher starting yields, shorter duration and stronger credit quality can provide a more balanced way to access the opportunities available across fixed income.
Fixed Income
Mirabaud Global High Yield Bonds
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