Capital Ideas^™ 
Investment insights from Capital Group

Over the past five years, financial markets have navigated an exceptionally turbulent period that has been marked by multiple severe shocks. These include the pandemic in 2020, aggressive rate hikes by central banks in 2022, the geopolitical upheaval from the Russia-Ukraine war in February 2022, the banking crisis in the United States in 2023 and the imposition of new tariffs in 2025. Despite these significant disruptions, the high-yield (HY) market has demonstrated remarkable resilience and has outperformed most other fixed income sectors by a substantial margin.

There are reasons to believe structural changes in the high-yield market have made it more resilient to shocks and we believe it appears well-positioned to continue to deliver strong results in the future. These strengths also could partially explain why spreads have been trading at relatively tight levels compared to long-term historic averages and can continue to do so absent an external shock.

High yield has outpaced most fixed income sectors since 2020

Chart source(s): Bloomberg. Data as of May 31, 2025. Past results are not predictive of results in future periods.

The high-yield market is no longer junk

The composition of the HY market has undergone a significant transformation over the past two decades. Since the global financial crisis (GFC) in the early 2000’s, there has been a transfer of leverage from the private sector – corporates and households – to the public sector and this has made corporates much more disciplined in how they approach debt. Consequently, the quality of companies within the HY index has markedly improved. The BB cohort — the highest quality segment within HY — now constitutes more than 50% of the index; the B and CCC cohort has been shrinking over the past 15 years.

At the same time, secured bonds have reached a record high representing approximately 42% of the market. This structural change, driven by issuers seeking lower refinancing costs providing collateral, especially among lower rated names, has influenced the rating quality shift and improved their risk profile.

These improvements in quality and structure explain not only why spreads have been trading below historic averages in recent years but also why the HY market has been resilient during periods of stress. Investors are effectively taking less credit risk in today’s HY market.

The credit quality of the high-yield markets has improved

High-yield index ratings quality mix

Chart source(s): Bloomberg. Data as of June 30, 2025.

Current backdrop is supportive of HY spreads

Corporates appear to be in good shape with strong fundamentals. While sales and earnings growth have moderated (although, importantly, both remain positive), total debt outstanding is largely unchanged. This means both leverage ratios and interest coverage ratios are in a strong starting position to navigate a potential economic slowdown and to absorb part of the cost increases expected to result from current U.S. trade policy.

Additionally, year-to-date, HY issuance has been relatively subdued, falling below the average levels observed over the past four years. This trend reflects the cautious stance of issuers in the face of higher borrowing costs. Looking ahead, the outlook for HY issuance remains relatively benign. A substantial portion of the maturities for 2025 and 2026 has already been addressed, with less than 5% of the HY market expected to require refinancing by end of year. This limited refinancing need suggests a relatively stable issuance environment in the near term. With U.S. policy rates in the middle of the easing cycle, companies have ample room to wait for rates to normalize gradually and address their maturity walls in 2028 and beyond.

Market technicals remain supportive

U.S. supply issuance muted vs. recent averages

Chart source(s): J.P. Morgan data as of May 5, 2025.

Over the past decade, there has been a notable shift in corporate capital-raising preferences, with many companies opting for private credit and loans over the traditional HY market. This preference is driven by the flexibility to negotiate tailored deals with private credit managers and banks, which better align with their specific needs. The shift is expected to continue, providing a strong technical tailwind for the HY market as demand exceeds supply. In turn, this should help push spreads tighter.

Consequently, while the aggregate size of the HY market has remained relatively flat over the past 10 years, the private credit and leveraged loan markets have expanded, exponentially overtaking HY. The trend is particularly evident in leveraged buyout (LBO) transactions, which were previously heavily reliant on HY bonds. Over the past 20 years, there has been a noticeable shift toward leveraged loans. And in the past five years, the market has grown to be dominated by private credit, which has become the preferred choice for the vast majority of LBO transactions.

Plenty of opportunities to find value through active management

Since “Liberation Day” in early April 2025, dispersion within the high-yield market has surged to levels not seen in the past five years. Despite relatively tight index spreads, the standard deviation of option-adjusted spreads (OAS) in the HY universe has widened sharply – signaling a growing divergence in credit risk pricing across issuers.  While HY spreads have almost remained unchanged year-to-date, transportation and energy have been clear underperformers while REITs (real estate investment trusts) and consumer non-cyclicals have been the strongest in this period (as of June 25, 2025).

This divergence is further evidenced by the distribution of securities. Over 500 bonds trade above the index average OAS, and nearly 200 exceed it by more than 200 basis points. Such a wide variation in spreads reflects heightened investor scrutiny and the uneven sectoral impact from macro shocks — particularly the tariff-driven volatility that followed Liberation Day. This variation helps create multiple opportunities for bottom-up active investors to capture value.

High yield can offer compelling opportunities for active management

Despite tight index level spread, dispersion at the security level is elevated

Chart source(s): Bloomberg, Capital Group, Barclays Research. As of May 31, 2025. Dispersion is defined as the standard deviation of OAS divided by the weighted average index OAS, winsorized at the 1% level, with extreme values capped at the 1st and 99th percentiles, using monthly data.

Sectors such as REITs continue to appear attractive due to their robust cash flows and predictable earnings, even in a potential scenario where the economy slows down. REITs benefit from stable rental income and property appreciation. Conversely, sectors like capital goods, building materials and autos are potentially more exposed due to their cyclical nature and vulnerability to an escalation of trade barriers between countries.

These more vulnerable sectors often face significant volatility and capital-intensive operations, which can strain their financial stability during economic slowdowns. Therefore, it is important to be selective and active to extract value in an environment where valuations at an aggregate level are tight. Today, selectivity is more important than ever due to the uncertainty around how, when and where tariffs will be implemented.

High-yield volatility has been muted relative to investment grade

Chart source(s): Barclays. Data as of June 30, 2025. Indexes: HY: Bloomberg U.S. Corporate High Yield 2% Issuer Capped Index, IG: Bloomberg U.S. Corporate Investment Grade Index

What can investors expect going forward?
  
In the absence of an external shock, spreads can remain below historical averages for an extended period. Such a scenario has been not uncommon, historically speaking. Spreads remained at very tight levels for several years during the 1990s and 2000s. In the past 15 years when HY spreads have been tighter than long-term historic averages, the U.S. Corporate High Yield 2% Issuer Capped Index has outpaced the U.S. Aggregate Index by more than 50% on average over the next 12 months. As the following chart highlights, the two indexes have delivered 12-month forward results under such periods of 4% (U.S. HY) and 2.5% (U.S. Aggregate).

Return differential between HY and broader bond market

Chart source(s): Bloomberg. As of December 31, 2024.

Additionally, investors can benefit from a more resilient asset class. The gradual increase in quality has also made the U.S. HY market much more resilient to stress periods than in the past. This resilience was evident in the recent drawdown post Liberation Day in early April this year. Unlike previous instances such as from June to December 2008, where U.S. equities and U.S. HY traded in line falling -28.5% and -25.1% respectively, this year, the drawdown in U.S. HY was a fraction of that experienced by equities (-15% fall in S&P 500 vs. -1.8% fall in U.S. HY –January 1 to April 8, 2025).