Global High Yield Bonds Offer Attractive Income Potential

A Conversation with Payden & Rygel

Investors looking to diversify the fixed income portion of their portfolios are looking to the global bond market, including high-yield bonds. Payden & Rygel’s Timothy Crawmer and Frasat Shah share their views on how monetary policy and economic forces might affect the asset class.

Summary

Despite tight spreads, global high yield offers attractive income potential relative to other fixed-income segments. Strong fundamentals, lower duration, and steady flows position high yield (HY) as a compelling allocation in today’s environment.

• Rate cuts: Positive for HY if inflation falls with strong labor markets; negative if cuts are driven by recession.
• Flows: Strong inflows into HY; cash still in money markets and some will likely move to HY as rates fall.
• Region: No cheap region; focus is on issuer selection.
• Defaults: Muted at ~3%, concentrated in media/telecom/retail. Broad balance sheets remain strong.
• Quality bias: Focus on BB/B; very selective CCC exposure.
• Issuance: Net supply muted, demand outstrips issuance.
• Emerging Markets (EM): Opportunities exist, but exposure is cautious (avoiding China real estate, wary on commodities).
• Valuation: Spreads are tight, but yields are attractive; HY compares well vs. investment grade and equities in carry-driven environment.

Payden is looking for three to four rate cuts. How does that impact the attractiveness of global high yield bonds?

Shah: I think the positivity of a declining interest rate environment depends largely on why those interest rates are declining. The key for us is the labor market. If front-end rates are declining due to falling inflation against a robust labor market, then we’d argue that scenario is one that’s very positive for high yield credits. If we enter into aggressive rate cuts because inflation is falling and unemployment is rising, that’s a scenario where we think high yield is going to face more headwinds; you’re going to probably have elevated default rates and it’s going to be a harder scenario for high yield to perform.

A lot depends on the labor market. We’ve seen some softening in the labor market already and I think as more macro data becomes available, that will be the key for how the path of front-end rates plays out from here and how that might affect global high yield as an asset class.

What happens if the Fed doesn’t cut the rate as quickly as we’re thinking now? How would that impact the markets?

Crawmer: It would all come down to what is the cause of the Fed not cutting rates as fast as we expect. And there’s two reasons why they would do that. One is if inflation is higher than expected. It seems that part of the equation has gone down in importance with the Fed because inflation has been showing a downward trajectory. So that would be a big surprise for the market, and the Fed, if you saw inflation pick up and the Fed had to react to that by keeping rates higher. So that would definitely be a negative for the markets if that happened. We think that’s a pretty low probability of occurring.

The second part is if the labor market shows more strength than the way the recent numbers have been trending. And that would actually be a good thing for the market. If you have strength in the labor market without corresponding rising inflation and that led to economic activity coming in higher than expected, a strong consumer, all of those things. That’s going to be very supportive for risk assets and high yield.

How has the global high yield sector performed relative to other fixed income asset classes like investment grade and even equities in the rate cutting cycles? What does the past tell us?

Shah: It’s going to come back to the same things that we’ve been saying for the previous questions. It depends on what has preceded that rate cut cycle; so, the economic backdrop at the time. If cuts are followed by a recession, then that’s an environment where global high yields have historically struggled to perform. You’ve had out-performance of investment grade relative to global high yield and equity markets. Global high yield struggles as it is hit by rising default rates in a recession.

In that kind of scenario – a recessionary outcome facilitating the need for rate cuts –  that’s going to be a tough environment for global high yield to perform on a total return and an excess return basis and very likely not to outperform investment grade. But if you had a softer landing, these are preemptive rate cuts that lead to maybe decline in economic activity but not necessarily going into a recession. I think that kind of environment can be one where the carry of global high yield can outdo, on an excess return basis, investment grade corporate spreads. And you probably see equity markets, I think, outperform both in that scenario. So yeah, very dependent on the economic backdrop there.

What about the political environment here, the tariffs and other factors impacting the markets? What are you hearing from clients? Are they finding this less attractive area or more attractive environment?

Shah: I’m seeing flows into high yield. I’m seeing a lot of high yield investors have excess cash and not feeling like they can spend that at the rate that they’re receiving cash. And I think from what we’ve been seeing as a firm, there has been interest for high yield. And I think a lot of that is due to the fundamental robustness of these high yield companies and people are willing to go down the rating spectrum given, I guess, how robust some of these balance sheets are for that extra carry. So, I would say that it’s been attractive to investors, and they’ve been happy to put money to work in high yield.

Crawmer: I think there is a lot of cash on the sideline to Fras’s point. I think that there’s a lot of money that is still sitting in short duration products like money markets because you’re getting paid pretty well to hold that right now. But as the Fed starts cutting rates, that’s going to look less attractive and that money is going to continue to move into more risky assets as long as the economic backdrop stays relatively robust. And when you look across fixed income from a risk asset perspective, you’re really not getting paid that great in investment grade corporates because of the tight OAS [Option-Adjusted Spreads]. So, if you feel comfortable about the economy, you start having to move out the risk spectrum to pick up some attractive yield. So yes, I think that more money is out there that can move into the high yield space for sure.

Are you distinguishing between US fixed income assets and global?

Shah: I know there’s questions of how attractive is the US and what are flows like away from the US? If you were to look at the data for US investment grade, US high yield, European investment grade, European high yield, all those markets have seen healthy fund flows. So, to the extent that there is an aversion to US assets, I wouldn’t say it’s most starkly represented in investment grade and high yield corporates, but I do think you can see those kinds of preferences more in other markets. I think you can see it in treasury markets and how they performed relative to bonds back in the throes of Liberation Day. At the height of that volatility, you saw German bonds outperform US treasuries. That’s not necessarily what you would’ve seen, you wouldn’t have seen quite that stark performance in historical episodes.

I think that kind of diversification away from the US is being seen more in the treasury market than the global high yield one, but you are hearing anecdotally of investors and issuers being more inclined not to divest per se, but maybe just diversify their exposure at the margin going forward from here.

Let’s talk about where you’re seeing opportunities. Where are you investing now? What countries, regions?

Crawmer: From an opportunity set, I think there’s no low hanging fruit that’s screaming cheap. So, when you look across the global high yield landscape, US, Europe, emerging markets, they all have rallied from a spread perspective and there’s not a lot of negativity in one market that would cause it to be trading cheap to the other.

It really comes down to issuer selection and finding attractive issuers. And that’s our bread and butter here: really relying on our analyst team to dig through the opportunity set and find attractive issuers to invest in. Right now we’re relatively agnostic to geographic region and we’re really focused on making sure we have the right issuers in our portfolio.

What about default or outlook, the US, Europe, Global? Are you looking at different sectors for defaults?  Who has the strongest balance sheet? What are you avoiding?

Crawmer: There hasn’t been a lot of default action. It’s been a pretty muted situation given the strong backdrop in the markets. The default rate when you look at it just on an issuer basis is around three percent in both the US and Europe and it’s lower when you look at actually how much outstanding debt has defaulted. These were smaller issuers for the most part that defaulted. We think the default activity is going to pick up in 2026, but it’s not going to pick up meaningfully. And the one area where we are seeing more default activity is in the media and telecommunications space. So, some big names like Altice France have gone through a debt restructuring, Sinclair here in the US and that’s probably going to continue given the amount of leverage in that sector.  The vast majority of these stressed issuers have been very well advertised that they’re on the verge of defaulting or restructuring.  Therefore, it’s not going to surprise the market by any means.

Shah: I think the way we’ve come out of earnings this quarter has been testament that corporate fundamentals are quite healthy. You’re not seeing a lot of cracks across issuers. I think weakness is there in some parts of retail and the chemical space, but otherwise, yeah, I’d echo the same as Tim.

Your investments have tended towards the higher quality high yield. Does that continue to be your strategy or are you looking at distressed as well?  Do you feel it’s worth the risk to go down in quality?

Shah: Our strategy for the global high yield fund is to be focused on the BB-B part of the universe. We’ve found that historically that’s where you get the best risk adjusted returns. We think that CCC’s perhaps add more per unit of risk relative to returns. So we have that bias, that’s part of our philosophy and that’s how we structure the strategy. When it comes to the CCC side of the universe, we are looking to be involved in CCC’s when analysts have conviction on the credits.

And I think it’s fair to say we’re not necessarily looking to play a lot of distressed stories. That’s not our bread and butter. It’s really improving balance sheets of CCC’s that make their way into the fund. The exposure to CCC is currently muted. It’s around 2%, and we have been as high as 10% in the past. But as it currently stands, we’re not finding a lot that fits the bill for what makes it into our fund in terms of CCC exposure.

Crawmer: I think the key there is we don’t want to be forced to own CCC. We want to buy it when we see opportunities.

What do you think about new issuance? How is that impacting the market?

Shah: I would argue, relative to the amount of money making its way into high yield, there’s probably not enough new issuance. The net supply picture is very muted. Speaking from a European lens, we’ve had negative net issuance for the a few months this year. So you could say that there’s not enough to quench demand, but in terms of new issuance being interesting, yes, it’s always interesting. There’s plenty of issuers making their way into the market. You’re seeing a few inaugural issuers make their way onto the market as well.

There are still interesting issues that add value, and I think you can drive a lot of value in high yield markets through paying attention to new issues.

Why is new issuance not meeting demand? Is there the expectation of interest rates to coming down?

Shah: There are a few things. Maybe some issuers are delaying based on interest rate expectations, but I think there’s other avenues for financing as well. There’s the private market now as well. M&A has been a bit more muted. It’s picked up this year, but I think some of that leverage buyouts (LBOs) activity that catalyzes high yield markets has been a quieter. I think maybe we could see some of that pickup next year. But yes, I think it’s the different avenues of financing, some more muted activity on the M&A, LBO side as well. And maybe some issuers are also playing interest free expectations.

Crawmer: I think it speaks to the health of the high yield market in general. There aren’t a lot of companies that are looking to increase their debt loads to do M&A, LBOs, or things that historically have driven a big pickup in issuance.

What about Emerging Market (EM) high yield? Is that part of your portfolio? Are you seeing that as more attractive now? Less attractive?

Crawmer: On the EM side, it is part of the global high yield landscape and it is in our primary Global High Yield benchmark. We do of course have customized mandates that don’t include EM, but in the broader mandates it’s in there and it’s a big part of the universe.  Just as big as the European high yield market in size.  Additionally there are a lot of issuers to choose from and a very diverse opportunity set across the globe. There’s been some areas of weakness in that market with China real estate being a good example. That’s an area that we have stayed away from entirely.

There are also different weightings from a sector perspective in EM versus developed markets. In particular, there are more energy, metals and mining, and commodity related companies in EM. All of which are going to be very correlated to commodity prices.  Recently, we have been cautious on commodities and oil related exposure in particular. That has resulted in lower EM exposure than we have had in the past.

What about new issuance in EM?

Crawmer: It’s suffering from the same thing that Fras was pointing out as far as issuance. There’s not enough issuance to soak up the demand. When there are attractive issuers that come to market, the demand for those bonds is through the roof. So we’ve seen some deals come recently, e.g. Petrobras, that has garnered a lot of interest. In general, it’s the same situation in EM as it is in developed markets.

Is this an attractive entry point if people have been toying with the idea of getting into high-yield, global high-yield, is this a good time?

Shah: I think if you look at it from a spread perspective, everyone can see that we’re trading at historical tights. We’re in the low percentiles for where we are in the spread range. And it’s hard to argue that the spreads look extremely compelling here, but I think when you pair the overall yield of the asset class with a global economic backdrop that looks like it’s set to remain relatively robust and hopefully falling inflation too. And then also looking at some of the fundamentals of these companies across the high-yield universe, I think investors can get more comfortable with the running yield than they can the spread.

And I think that’s why you’ve seen the flows into the asset class. I think if you look at it from the spread perspective, then yes, it’s hard to argue for anything in fixed income right now. In the same way it’s hard to argue for equities looking at multiple. But I think from a yield perspective, yes, high yield probably does look interesting relative to equity markets in my opinion. And I think the other factors make it look all-in interesting from a total return perspective.

From your perspective, do you see global high yield as more attractive than investment grade or other fixed income asset classes?

Crawmer: I think the good thing about high yield is you get enhanced carry and enhanced yield with a lower duration than investment grade. So that combination helps high yield cure itself a lot faster from any type of spread widening. I think the situation we’re in right now is we’re not going to see a lot of spread tightening or capital appreciation. It’s going to be a carry type of environment. And when you’re invested in carry and not expecting capital appreciation, it’s really a question of when is the next sell-off going to happen? How long into the future, how long is it going to take before that next sell-off? And high yield will cure itself in a shorter amount of time than investment grade.

Are there things that keep you guys up at night? I mean, I know there’s a lot of turmoil going on to say the least, but is there anything that really scares you?

Shah: From a market perspective or from a world perspective, there’s plenty of things that are worrying or that are worth paying attention to. I think fiscal deficits is a big theme across the developed market landscape and how they play out. It’s a theme that will play out over time. You’ve seen that come to a head in France over the last couple of weeks. There’s elevated talk around the UK’s budget in the autumn and the fiscal deficit in the US continues to get larger. So, I think that is worrying for markets. I think it’s worrying for investors and it’s worrying for everyday people as well, because the question is how are these going to be funded because. I think that’s worrying.

Crawmer: Recovery rates are an interesting thing to look at because what’s been going on in high yield is over the years, covenants have become looser. As a result a lot more of the default action has actually moved into the liability management space where issuers can take advantage of those loose covenants. Companies will go in and restructure their debt instead of just entering into bankruptcy proceedings. There’s been a big divergence in recovery rates between those issuers that have outright defaulted and companies that have done liability management exercises.

For outright defaults, those recovery rates have gone down significantly. They’re in the 30% range, which is down from 60% historically which is a big move. But then if you look at the liability management side of things, those are still close to historical recovery rates of around 60%. It is a really interesting part of the market that a lot of the activity from a distress perspective is happening in the liability management arena rather than via outright bankruptcy proceedings. It’s a nuance that not everybody picks up on.

Is this an investable scenario?

Crawmer: Opportunistically, yes. The problem with investing in liability management situations is if you’re not in the information flow, you’re at a significant disadvantage. So, when they go into a liability management exercise for a company, it’s led by key investors. So, the biggest debt holders will drive the groups dictating that process. And if you’re not part of that group, you’re at a significant information disadvantage. You really need to be in the group to fully understand all the moving parts of the process. We generally try to stay away from situations where we’re at an information disadvantage.

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 has been approved by Payden & Rygel Global Limited which is authorised and regulated by the Financial Conduct Authority.  This material has been approved by Payden Global SIM S.p.A. which is authorised and regulated by CONSOB.