European high yield: Rising dispersion, a welcome diversion

February 26, 2025

If you have any feedback on this article or are interested in subscribing to our content, please contact us at opinions@muzinich.com or fill out the form on the right hand side of this page.

--------

Tight credit spreads don’t mean a lack of opportunities in European high yield; investors just need to work harder to find them, argue Thomas Samson and Jamie Cane.

Compression has been a defining feature of European high yield since late 2023, resulting in credit spreads falling to multi-year lows.¹ However, mostly sound fundamentals coupled with strong technical conditions mean spreads can stay compressed. And for as long as yields remain at or around their current elevated levels, carry should remain king, in our view.

At first glance, finding an attractive entry point into the asset class might seem challenging. But if you know where to look, we believe there are significant opportunities, while it has rarely been cheaper to protect portfolios in the event of any unforeseen shocks.

Not too hot, not too cold

Fears of a repeat of 2018, when the risk of recession loomed large, appear unfounded given differences in the European macroeconomic environment. Growth looks set to be moderately positive and the European Central Bank is expected to continue monetary easing.²

The asset class is also underpinned by a positive technical, with consistent inflows since late 2023. Net issuance has been limited as primary activity has focused on refinancings, while the asset class has shrunk due to rising stars (bonds upgraded to investment grade) outnumbering fallen angels (bonds downgraded to high yield).³ This has resulted in a scenario where more cash is chasing fewer bonds. 

High yield demonstrated impressive resilience during episodes of equity volatility in the second half of 2024, including the unwinding of yen carry trades and uncertainty ahead of the US election (Figure 1). Over 10 and 20-year periods, European high yield has also generated a better Sharpe ratio – a measure of returns relative to risk – than equities, investment grade bonds and bunds.⁴

Investors concerned about the risk of a deteriorating economy could look to long-short strategies able to implement additional portfolio protection, including through the use of options. The combination of tight spreads and low volatility, coupled with still-elevated yields, mean it has rarely been cheaper to hedge portfolios as a proportion of their carry (Figure 2).

Where’s the value?

Despite spread compression, there is currently a lot more dispersion (percentage of bonds trading at least 100bps tighter or wider than average index spreads) than previous tight spread environments such as 2017. Back then, dispersion was around 37%; today, it is closer to 70% (Figure 3). This has created a broader universe from which to select potentially mispriced bonds. Through in-depth credit research, we have identified good opportunities at an issuer, sector and regional level.

From a sector perspective, we believe European real estate is a source of opportunity, underpinned by the deleveraging and balance sheet strengthening measures implemented since late 2023. We also see opportunities in banks, where credit quality has improved markedly.⁵

Early refinancings of bonds trading due to mature in 2026 and 2027 that currently trade below par could offer additional convexity not captured by standard yield-to-worst metrics, while the primary market could offer attractive new issue premiums. A pick-up in new issuance could provide another source of alpha.

Defensively positioned

European high yield also looks relatively defensive when assessed from a spread versus average duration perspective. Bonds with shorter maturities typically have tighter spreads than longer-dated bonds because of lower repayment risk. The current duration of the asset class at approximately 3 years is shorter than usual and should influence how spreads are assessed (Figure 4).

Yields in the BB and B-rated market are currently around 4.6%.⁶ This means spreads could widen by 150 basis points before reaching their breakeven point (when the total return turns negative). The cushion is even larger when considering the full market, including CCC-rated bonds, at 5.5%.⁷

Balancing act

While the outlook for growth in the euro area is modest, particularly when compared to the US, it is important to remember the region has rarely experienced sustained periods of strong growth. One notable data point is the unemployment rate, which is close to its historic low (Figure 5). This should support consumer spending, a key driver of GDP.

We may see slower economic growth and a modest rise in unemployment. But, given the strong starting point, we believe it would be difficult for these factors to trigger a severe downturn or material rise in defaults. Any potential fall in growth is likely to offset, to an extent, a tailwind from lower rates, while spreads would remain tight in an environment of stronger growth.

In summary, while European high yield spreads are tight at the broader market level, high dispersion could present significant opportunities for astute investors, while the relatively short duration of the asset class offers defensive properties for any uncertainty ahead.

 

References

1.ICE Data Platform, ICE BofA European BB-B European Currency Non-Financial High Yield Constrained Index, as of February 25, 2025
2.European Central Bank, ‘Eurosystem staff macroeconomic projections for the euro area,’, December 2024
3.ICE Data Platform, ICE BofA Euro High Yield Index, as of February 2025
4.Muzinich, ‘We need to talk about Sharpe ratios,’ November 27, 2024
5.S&P Global, ‘The Top Trends Shaping European Bank Ratings In 2025,’ January 27, 2025
6.ICE Data Platform, as of January 31, 2025. ICE BofA BB-B Euro High Yield Constrained Index.
7.ICE Data Platform, as of January 31, 2025. ICE BofA Europe High Yield Constrained Index.

This material is not intended to be relied upon as a forecast, research, or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed by Muzinich & Co are as of February 2025 and may change without notice.

--------

Index descriptions

HE00 - The ICE BofA  Euro High Yield Index tracks the performance of EUR dominated below investment grade corporate debt publicly issued in the euro domestic or eurobond markets. Qualifying securities must have a below investment grade rating (based on an average of Moody’s, S&P and Fitch), at least 18 months to final maturity at the time of issuance, at least one year remaining term to final maturity, a fixed coupon schedule and a minimum amount outstanding of EUR 250 million.

HEC0 – The ICE BofA  Euro High Yield Constrained Index contains all securities in the ICE BofA  Euro High Yield Index (HE00) but caps issuance exposure at 3%.

HEC4 – The ICE BofA  BB-B Euro High Yield Constrained Index contains all securities in the ICE BofA  Euro High Yield Index (HE00) rated BB1 through B3, based on an average of Moody's, S&P and Fitch, but caps issuer exposure at 3%.

HP4N – The ICE BofA  BB-B European Currency Non-Financial High Yield Constrained Index contains all non-financial securities in The ICE BofA  European Currency High Yield Index rated BB1 through B3, based on an average of Moody's, S&P and Fitch, but caps issuer exposure at 3%.

Important information

Muzinich and/or Muzinich & Co. referenced herein is defined as Muzinich & Co., Inc. and its affiliates. Muzinich views and opinions.  This material has been produced for information purposes only and as such the views contained herein are not to be taken as investment advice. Opinions are as of date of publication and are subject to change without reference or notification to you.   performance is not a reliable indicator of current or future results and should not be the sole factor of consideration when selecting a product or strategy. The value of investments and the income from them may fall as well as rise and is not guaranteed and investors may not get back the full amount invested. Rates of exchange may cause the value of investments to rise or fall.

Any research in this document has been obtained and may have been acted on by Muzinich for its own purpose. The results of such research are being made available for information purposes and no assurances are made as to their accuracy. Opinions and statements of financial market trends that are based on market conditions constitute our judgment and this judgment may prove to be wrong. The views and opinions expressed should not be construed as an offer to buy or sell or invitation to engage in any investment activity, they are for information purposes only.

This discussion material contains forward-looking statements, which give current expectations of future activities and future performance. Any or all forward-looking statements in this material may turn out to be incorrect. They can be affected by inaccurate assumptions or by known or unknown risks and uncertainties. Although the assumptions underlying the forward-looking statements contained herein are believed to be reasonable, any of the assumptions could be inaccurate and, therefore, there can be no assurances that the forward-looking statements included in this discussion material will   prove to be accurate. In light of the significant uncertainties inherent in the forward-looking statements included herein, the inclusion of such information should not be regarded as a representation that the objectives and plans discussed herein will be achieved. Further, no person undertakes any obligation to revise such forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.

United States: This material is for Institutional Investor use only – not for retail distribution. Muzinich & Co., Inc. is a registered investment adviser with the Securities and Exchange Commission (SEC). Muzinich & Co., Inc.’s being a Registered Investment Adviser with the SEC in no way shall imply a certain level of skill or training or any authorization or approval by the SEC.

Issued in the European Union by Muzinich & Co. (Ireland) Limited, which is authorized and regulated by the Central Bank of Ireland. Registered in Ireland, Company Registration No. 307511. Registered address: 32 Molesworth Street, Dublin 2, D02 Y512, Ireland. Issued in Switzerland by Muzinich & Co. (Switzerland) AG. Registered in Switzerland No. CHE-389.422.108. Registered address: Tödistrasse 5, 8002 Zurich, Switzerland. Issued in Singapore and Hong Kong by Muzinich & Co. (Singapore) Pte. Limited, which is licensed and regulated by the Monetary Authority of Singapore. Registered in Singapore No. 201624477K. Registered address: 6 Battery Road, #26-05, Singapore, 049909. Issued in all other jurisdictions (excluding the U.S.) by Muzinich & Co. Limited. which is authorized and regulated by the Financial Conduct Authority. Registered in England and Wales No. 3852444. Registered address: 8 Hanover Street, London W1S 1YQ, United Kingdom. 2025-02-25-15553