High yield debt can play a key role as an allocation in a well-managed portfolio, offering an attractive risk/reward profile that has historically generated equity like returns with lower volatility. But recession fears abound, US protectionism is raising inflation expectations, corporate earnings may have peaked, and high yield defaults could rise from historic lows. So, how should investors allocate to high yield amid such uncertainty?
While we may be on the cusp of recession, we believe this cycle may play out differently, with some sectors suffering while others outperform. In addition, regional monetary policy divergence and changing trade dynamics are creating opportunities that, we believe, favor active managers who can carefully select among the potential winners and losers.
This time could be different
The theme of 2025 is uncertainty, driven by evolving US trade policy and elevated geopolitical tensions. The International Monetary Fund sees slowing global growth ahead— 3% for 2025 and 3.1% for 2026—below the 3.3% it projected for both years in January and well below pre-pandemic averages of 3.7%. It now forecasts global inflation of 4.2% in 2025 and 3.6% in 2026, with US prices likely creeping higher because of tariffs.
Still, amid signs we may be headed for recession, this credit cycle could play out differently. Corporate balance sheets are relatively strong after recently adapting to the shock of the 2020 pandemic. So, rather than a generalized recession like the Global Financial Crisis, we may instead experience mini cycles where certain sectors struggle (think the Real Estate sector in 2022-2023 and segments of Telecoms/Utilities in 2025), while others fare better.
Economic signals suggest recession ahead
Figure 1: Navigating the credit cycle
Source: Man Group . For illustrative purposes only.
Strain creates opportunity
If investors are confused, it’s little surprise. Buoyed by high interest rates, US corporate earnings have been strong, and the S&P 500 Index hit record highs in late July even as a new US-EU tariff deal increased inflation expectations. However, corporate earnings are a trailing indicator that say more about the past than the future. At Man, we anticipate lower earnings ahead because forward-looking indicators give reason for caution. For example, companies have significantly pulled back on hiring and investment plans, as seen in the US capital expenditure intentions indicator falling in April to its lowest level in five years (see the chart below).
Figure 2: US capital expenditure intentions indicator lowest since 2020
Source: Conference Board, Bloomberg, as of 31 May 2025.
The active opportunity
We believe these conditions may present an opportunity for active high yield managers to generate out-performance. Corporate balance sheets are relatively strong, and US defaults are near historic lows, but with US high yield leverage ticking higher, there has also been a spike in the number of firms undertaking distressed debt restructurings. We think this favors managers adept at credit analysis. The situation is different in Europe, where leverage among high yield firms is healthier, buoyed by the European Central Bank cutting interest rates ahead of the US Federal Reserve. In addition, technical factors are creating market inefficiencies—the fragmented nature of European bond markets and differing bankruptcy regimes across EU states—that we believe active managers can exploit.
We believe these conditions favor high yield portfolios that focus on:
- Rigorous credit analysis: this is not time to “buy the benchmark” but to undertake bottom-up security selection with a strong focus on issuer solvency, ability to repay debt, and credit quality outlook
- Top-down context: regional disparities, from corporate fundamentals to diverging monetary policy, underscore the importance of focusing on macroeconomics
- A diversified approach: we believe circumstances favor unconstrained managers who can invest across regions and sectors based on evolving opportunities
With uncertainty expected to persist, it makes sense that investors consider high yield, seeking equity-like returns with lower volatility. However, in such volatile times we believe high yield managers should follow an active, unconstrained approach. That could mean tilting toward distressed opportunities, certain regions, or sectors. For example, we currently see potential opportunities among global food manufacturers and energy services and among select high quality European real estate and financials. Conversely, we see elevated risks in automakers, US regional banks and among some US house builders. As the credit cycle evolves, opportunities will shift, too—a dynamic that, in our view, favors active high yield managers taking an unconstrained approach .
Past performance does not guarantee future results. High yield investments involve credit risk, interest rate risk, and potential loss of principal. This material is for professional investors only.
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