High yield in a shifting world: Alpha, allocation, and opportunity

When we speak, it’s almost a week after Trump’s ‘Liberation Day’ speech and markets are in freefall. Trade wars have erupted, and economists are scrambling to make sense of it all.

Yet, as Sander points out, this kind of volatility plays to the strengths of a high yield strategy with a low-risk, quality tilt. He breaks down the key alpha drivers for high yield in 2025 and why, despite the turbulence, it still deserves a place in investor portfolios – especially now.

The credit team recently published its outlook: Divorce and dispersion. Based on this, what are the top three alpha drivers for high yield in the coming quarters?

“The first important driver will be regional allocation, so the fact we are overweight European high yield and underweight US high yield will benefit our position. Europe is outperforming, and I expect this to continue because the US is shooting itself in the foot. The risk of a US recession – or even stagflation scenario – should not be ruled out and this is not the case in Europe. The US loses trade with all its trading partners, whereas Europe mainly loses the US but can still trade with other countries and continents like Asia.”

“The second driver is dispersion. Quality and low-quality credits will drift apart. Lower-quality names, such as triple Cs – which we are structurally underweight – will be hit by lower growth, potentially higher spreads and refinancing challenges which will create more defaults. Our overweight stance in higher-quality names should help relative performance, as higher spreads do not always mean higher returns, especially when defaults occur. Spread is not the same as return – something that becomes clear in volatile periods. As quant research has shown, lower-spread names can deliver higher returns in the high yield universe.

“The third driver is the financials versus corporates positioning. We are overweight financials, which tend to be more domestically focused and shielded from international tariff issues, because they primarily lend to small and medium-sized enterprises (SMEs) within their own country.”

“Additionally, issuer selection is critical – especially during downturns – and this distinguishes good from bad managers. All our analysts work toward issue selection on a daily basis.”

Was the quality bias a key factor in last year’s relative performance?

“Yes, last year we saw spreads generally decline, with high-spread names and CCCs outperforming. Due to our quality tilt, we had a beta below 1, causing us to underperform during such rallies.”

“But our strategy is designed to outperform in the kind of volatile environment we are now heading into by maintaining an overweight position in higher-quality issuers like BBs and Bs and staying structurally underweight in riskier, lower-quality segments like CCCs.”

And how is the strategy positioned now?

“Things are moving very quickly at the moment. As contrarian investors, that’s where we see value – even if the macro backdrop feels uncertain. We’ve gradually increased the portfolio’s credit beta toward 1.0, mainly through CDS indices like CDX while maintaining our quality approach. CDS indices are highly liquid and tend to move quicker than the cash bond market, especially at the start of a sell-off. That gives us a way to add credit risk early on, before the cash market fully catches up. It’s a flexible approach that helps us stay ahead in fast-moving markets.”

Beyond banks driving the overweight Europe position, are there other factors?

“Valuations were cheaper in Europe at the beginning of this year, although now they’re more in line with the US. I think Europe's fundamental outlook has relatively improved because the outlook in the US has clearly deteriorated. And fiscal spending in Europe, particularly in the defense sector, can soften the blow of tariffs.”

How does inflation and interest rate uncertainty impact your decision-making?

“I think the nice thing about high yield is that it always has two components: the spread and the yield. In a recession, what typically happens is that government bond yields fall, while credit spreads widen. These two effects can partially offset each other, which helps cushion the impact on overall returns. However, there is a risk that this dynamic might change when people lose trust in Treasuries.”

“We don’t take active duration bets – we keep our duration closely aligned with the benchmark. But we do watch interest rate forecasts carefully, as they are relevant for the funding rates for companies.”