Falling interest rates suggest now is the time for investors to refocus on fixed income and away from cash on deposit. A combination of improving macroeconomic conditions, strong fundamentals, and a relative undervaluation of the European market means that high-yield corporate bonds are one of those sectors that can help diversify your portfolio, can offer attractive yieldsand has generally lower volatility than equities. In addition, the sector can offer the opportunity for capital appreciation, with ratings upgrades, improved earnings reports, mergers and acquisitions and market-related events all likely to push up prices.
An improving background for fixed income
Inflationary pressures have abated, and European central banks have embarked on a rate-cutting cycle. With interest rates falling and bond yields at compelling levels, investors are now incentivised to move their assets out of cash and back into fixed income. The fixed-income market, however, is not homogenous. The appeal of different parts of this broad asset class can vary, depending on where we are in the market cycle. By analysing multiple viewpoints, areas of the fixed-income market that are particularly interesting to clients seeking sustainable returns can be targeted. Currently, Euro high-yield corporate bonds have the potential to be one of the sectors offering compelling opportunities to investors.
Encouraging macro backdrop across Europe
Critically, long-term bond yields are much more susceptible to these shocks than the short-term instruments, while demand for short-term bonds is also expected to remain robust, limiting the upside for yields. That’s because investors are rotating away from increasingly lower-yielding money-market funds to higher-yielding instruments as interest rates around the world trend downwards.
There is also a strong argument in these volatile and ever-changing times, for having a diversified portfolio with dynamic allocations and multiple return streams that responds to market and economic conditions and evolves over time. Diversification can therefore significantly reduce isolated fixed income sector risk.
Furthermore, by deploying long/short strategies, it is possible to generate returns whichever way markets are moving. These strategies, which can help smooth returns, are not part of the opportunity set for managers of conventional fixed-income strategies.
Where to find opportunities
Europe’s brightening economic outlook should prove supportive for the financial health of borrowers in the high yield sector. Strengthening demand, particularly considering the shift towards spending and defence, should boost earnings growth while falling interest rates should also ease pressure on balance sheets. European growth is stabilising, albeit at a low level. Over the course of 2025, various developments – such as an end to the Ukraine war – could lift the clouds over the continent and further improve the outlook.
There are a variety of other positive factors. The result of the German federal election in February, for example, is likely to lead to the formation of a business-friendly administration that will prioritise economic growth in Europe’s largest economy. The parties aiming to form a new coalition have already agreed plans to significantly boost spending in areas such as defence and infrastructure.1
The European Commission (EC) has also unveiled a new plan aimed at addressing the EU’s deep-seated structural issues and boosting economic growth.2 The EC’s plans to slash red tape and exempt a swathe of European corporates from sustainability reporting rules highlight the new focus on growth and deregulation.3
In addition, the European Central Bank (ECB) embarked on a rate-cutting cycle in 2024,4 and further easing is expected this year – rates having fallen to 2.5% in March5 – as inflationary pressures ease. The ECB is on course to cut its lending rate to 2% by mid-year.
Euro high yield’s solid fundamentals
Over the past two years, the Euro high-yield sector has demonstrated resilience to external shocks and developments within the high-yield universe, highlighting the asset classes’ potential as a portfolio diversifier. This shows the sector is now more mature and of better intrinsic quality than a few years ago. That should support their capital preservation attributes and contribute to rising values, delivering capital gains to investors.
The technical factors that supported the Euro high-yield segment in 2024 – namely, inflows into mutual funds and demand for collateral for Collateralised Loan Obligations – are here to stay in 2025. Corporate results for the region continue to demonstrate the resilience of business models. Profit margins are stable, default rates have declined, costs are well under control, and there is sustained cash generation. Overall, high-yield issuers are maintaining solid and resilient financial ratios, and further improvements in 2025 are possible.
Why Euro high yield?
Following two years of strong performance – 12.78% in 2023 and 8.92% in 2024 –the Euro high-yield market should appeal to investors seeking income and capital preservation. Yields, at 5.03%6, remain compelling – particularly if, as expected, eurozone interest rates (and income from cash deposits) continue to decline. The bonds offer potential for capital appreciation, with ratings upgrades, improved earnings reports, mergers and acquisitions and market-related events likely to push up prices. Yields are significantly greater than on government bonds and many investment-grade bonds.
Valuations are also sustainable. Although spreads – the difference between yields on Euro high-yield bonds and the benchmark yield – tightened significantly in 2024, they have remained at similar levels for significant periods in the past. Demand is expected to remain robust, supporting yields, as investors are rotating away from increasingly lower-yielding money-market funds to higher-yielding corporate-bond funds.
At the same time, supply is constrained as companies focus on reducing or restructuring debt, rather than borrowing to finance expansion. As relatively short-term instruments, Euro high-yield bonds are less volatile than equities. They also benefit from lower correlation with movements in interest rates than longer-dated bonds making them resilient and provide diversification in an investor’s portfolio.
In this fast-changing world, BNPP AM uses the insights generated by looking at markets from multiple perspectives to capture the best opportunities in the Euro high yield sector and generate long-term sustainable investment returns for our clients.
Benefit from our extensive expertise
Portfolios are constructed by combining views on the outlook for the wider economy with in-depth analysis of individual companies. Following a high-conviction strategy, areas of the market that have the potential to deliver returns to investors – such as undervalued European corporates – are targeted.
The fund managers have more than 20 years of experience in issuer selection and are supported by a dedicated and experienced in-house credit-analyst team. The fund has a track record stretching back to 2003 and over 2 billion euros of assets under management. Environmental, social and governance concerns are integrated through the bond-selection process.
The aim is to manage risk by targeting those companies where risk is limited and the perspectives over the short maturity horizon are positive, while avoiding those whose prospects are not as good.
View fund[1] https://www.reuters.com/world/europe/key-details-germanys-proposed-fiscal-rule-changes-infrastructure-splurge-2025-03-04/
[2] https://commission.europa.eu/topics/eu-competitiveness/draghi-report_en
[3] https://www.politico.eu/article/brussels-plans-sweeping-cuts-to-eus-green-rules-leaked-bill-reveals/
[4] https://tradingeconomics.com/euro-area/interest-rate
[5] https://www.bbc.co.uk/news/articles/c30mz648nyno
[6] https://tradingeconomics.com/euro-area/interest-rate
