High Yield Markets

Higher interest rates have reshaped fixed-income markets, yet high-yield continues to attract investor interest on both sides of the Atlantic.

In this conversation, Payden & Rygel’s Jordan Lopez and Frasat Shah, who are based in Los Angeles and London, respectively, discuss how they are positioning U.S. and European high-yield bonds in their portfolios, and where they see the best opportunities and the risks for investors in the months ahead.

Despite higher government bond yields, why does high yield remain attractive?

Jordan Lopez: Many investors focus on the fact that spreads are relatively tight, but high yield investors tend to focus on all-in yield. In the U.S. high yield market, yields remain attractive by historical standards. Starting yield has historically been one of the strongest predictors of future returns over a multi-year period.

The asset class also offers a different risk profile from equities. Investors can potentially earn attractive income while taking less downside risk than they would in equities. That combination remains compelling, particularly for investors looking for income and diversification.

Frasat Shah: In Europe, the comparison with government bonds is not just about income; it is also about volatility. Long-dated government bonds can offer attractive coupons, but they also carry significant mark-to-market risk when rates move.

High yield has a shorter-duration profile, which can help reduce sensitivity to interest-rate volatility. For investors who want income but are wary of the price volatility in longer-dated sovereign bonds, European high yield continues to have a role to play.

How should investors think about duration risk today?

Frasat Shah: The past few years have reminded investors that duration matters. Higher-quality government bonds are not risk-free from a price perspective, particularly at the long end of the curve. In the UK, gilt volatility has been a clear example of how painful long-duration exposure can be when rates move unexpectedly.

High yield is not immune to volatility, but its shorter duration can make the return profile more balanced. Investors are being paid income while taking less direct exposure to long-duration interest-rate risk.

Jordan Lopez: U.S. high yield is currently one of the shortest-duration areas of fixed income. That matters because, if rates rise, the price impact tends to be more muted than in longer-duration bonds.

Another important point is that most of the return in high yield comes from coupon income. Even when there is some price volatility, the income component can help cushion returns over time. Historically, high yield has also tended to perform reasonably well during periods when rates rise, because spread compression can offset some of the increase in government bond yields.

How do public high yield markets compare with private credit today?

Jordan Lopez: We think public high yield looks attractive relative to certain areas of private credit. One reason is liquidity. Public markets allow investors to adjust positioning as fundamentals change.

Another issue is sector exposure. Private credit has meaningful exposure to technology and software companies, and some of those businesses may face pressure as artificial intelligence changes the competitive landscape. In public markets, that repricing can happen quickly and transparently. In private markets, valuations may take longer to adjust.

Frasat Shah: European investors are asking many of the same questions. Private credit has grown significantly, but public high yield still offers transparency, liquidity and daily price discovery.

That does not mean public markets are without risk, but it does mean investors can respond more quickly when conditions change. In an environment where growth, rates and refinancing conditions are all in focus, that flexibility is valuable.

Where are you finding the most attractive opportunities?

Jordan Lopez: Our approach is bottom-up, so we are not making broad allocation decisions based only on ratings categories. That said, we are currently finding many attractive opportunities in single-B rated issuers.

Earlier in the cycle, there were more opportunities in performing triple-C credits. After a strong rally in that part of the market, the relative value became less compelling. When we can move up in credit quality without giving up much yield, that is generally a trade we want to make.

Frasat Shah: We are also finding opportunities in the single-B part of the European market, but selectivity is very important. The key question is whether companies can continue to generate cash flow and manage refinancing needs if rates remain higher for longer.

We do not expect an extended European Central Bank hiking cycle to become the base case, but we are watching the policy outlook carefully. In our view, fundamentals in many single-B issuers remain resilient, provided investors are disciplined in credit selection.

Are default risks rising?

Jordan Lopez: In the U.S. high yield bond market, default rates remain relatively low compared with long-term historical averages. We may see some increase, but we do not expect a material rise in defaults across the broader high yield bond market.

The leveraged loan market is a different story. There is more exposure to technology and software companies, and some issuers face higher financing costs and refinancing challenges. We expect default pressure to be more pronounced in loans than in high yield bonds.

Frasat Shah: In Europe, we are also focused on refinancing risk, especially among lower-quality issuers. However, our base case is not for a broad default cycle.

The market is differentiating more carefully among issuers, which is healthy. Companies with durable cash flow and access to capital should remain well positioned, while weaker issuers will face greater scrutiny. That environment creates opportunities for active managers.

Which sectors are you approaching most cautiously?

Frasat Shah: Software is an area we are approaching with caution. Artificial intelligence is changing the outlook for parts of the sector, and it is difficult to identify winners and losers.

We have also been selective in European chemicals. The sector has seen periods of strong price performance, but it remains sensitive to energy costs, supply chains and broader economic conditions. We think there may still be structural support in parts of the sector, but it is not an area where investors should be indiscriminate.

Jordan Lopez: In the U.S., we are also cautious on software and technology-related credits where valuations or business models may not fully reflect the risks from AI disruption.

We have also been structurally underweight certain leisure issuers. In some cases, valuations are tight, upgrade potential is limited and the downside risk in a recession could be meaningful. For us, the risk-reward profile has not been compelling.

What should investors watch in the second half of the year?

Jordan Lopez: For U.S. high yield, the key issues are starting yields, corporate fundamentals and whether the market continues to compensate investors for credit risk. We still see attractive opportunities, but active security selection is critical.

The market is not cheap across the board. Investors need to be careful about where they take risk and avoid reaching for yield in credits where the downside is not adequately priced.

Frasat Shah: In Europe, we are watching growth, central bank policy and refinancing conditions. The market can absorb a modestly higher-rate environment, but investors need to be thoughtful about issuer balance sheets and cash-flow durability.

We continue to believe European high yield can offer attractive income and relative value, but the opportunity is not about buying the market broadly. It is about identifying issuers that can perform through a more complex macro environment.

Jordan Lopez is a Managing Director at Payden & Rygel and is the head of the high yield strategy group.
Frasat Shah is Portfolio Manager – Global Fixed Income and Senior Vice President at Payden & Rygel.

This material reflects the firm’s current opinion and is subject to change without notice. Sources for the material contained herein are deemed reliable but cannot be guaranteed. This material is for illustrative purposes only and does not constitute investment advice or an offer to sell or buy any security. Past performance is no guarantee of future results. This material reflects the firm’s current opinion and is subject to change without notice.

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