European High Yield for Allocators

Investing strategically into high yield corporate bonds can help to supplement yield or income objectives or help to diversify away from traditional stock/bond risks.
Historically, the higher quality segment of this market has realized better risk-adjusted returns, where inclusion of lower quality names can provide more potential upside particularly in risk-on markets.
European High Yield returns have historically been quite resilient even in slow economic growth environments. Even in modest negative growth quarters, returns have averaged between 1.5 and 2 percent, or rough 6 to 8 percent per annum over the past 2 decades.
While distressed market environments can introduce significant price volatility, subsequent returns following periods of spread widening have, on average, fared well for higher yield investments.

Historically, investors have looked to fixed income markets to access higher quality, fixed rate returns to either supplement yield or income objectives or to help diversify away from traditional equity risks that often dominate portfolios. The growth and expansion of credit markets in the past couple of decades has resulted in the tremendous growth of speculative-grade credit, now more commonly known as high yield. Once considered to be a more exotic, non-core fixed income asset class, the European high yield market has matured into a deep, liquid asset class that is now well-diversified across industries and issuers and now serves an important strategic and tactical purpose within most investor portfolios across the risk spectrum. As corporate bond markets have matured, the expansion into higher yielding fixed income has resulted in tremendous growth and maturation of the high yield market in Europe as a core exposure for fixed income investors.

This paper seeks to provide the reader with a broad overview of the Euro high yield market, highlighting the strategic and tactical cases for high yield investing as well as addressing questions around liquidity and market technicals, fundamentals around long-term defaults, characteristics of different segments of the high yield market, and how to think about the component risks of high yield bonds. The main areas of focus of this paper can be summarized into four categories:

Strategic Allocations: What is the strategic risk and return case for high yield within a portfolio, and what is a reasonable credit risk premium to be demanded by high yield investors?
Characteristics: What are the underlying characteristics of the high yield market, broken down by industry and by quality? How might shifting allocations based on industry or credit rating impact risk and return characteristics?
Market Timing: On a more tactical basis, when has it historically made more sense to be opportunistically overweight high yield as an asset class?

Component Risks: Between the credit spread and risk-free treasury yield, how have these component risks interacted or contributed to the total risk of the asset class?