KEY POINTS:
- Corporate fundamentals are robust and default expectations benign, but rising dispersion across sectors is creating distinct winners and losers
- Risks from geopolitical tensions in Middle East, unpredictable US trade policy, AI-driven disruption and a potential consumer slowdown mean the ability to respond quickly and flexibly to changes in market or macroeconomic conditions is more important than ever
- Supportive technical conditions (strong inflows, dynamic collateralised loan obligation creation and limited net supply) underpin spread resilience
Despite recent spikes in volatility the high yield segment continues to attract investor demand. Historically, returns tend to be higher than investment-grade or sovereign debt, and volatility lower than equities. This has helped to maintain appetite for euro high yield strategies since the start of the year.
This increased appetite for risk reflects a number of positive catalysts. Indeed, the asset class appears to have shrugged off the concerns of early 2025, when looming US tariffs and uncertainty around the path of interest rates in the eurozone weighed on sentiment. Euro high yield has remains in a a carry-dominated phase, where income, rather than further spread compression, is the primary driver of returns.
Performance based on strong foundations
Recent high yield performance has been built on a bedrock of strong corporate fundamentals. European companies of all types and sizes have emerged from the turmoil of the post-Covid period with healthy balance sheets relative to previous cycles. Expectations for defaults remain at low levels in historic terms, with stress localised in the weakest or most marginal issuers.
The macroeconomic outlook, meanwhile, remains benign. The eurozone economy expanded at a better-than-expected pace of 0.3% in the final three months of 2025. According to forecasts from the International Monetary Fund, this rate of growth will continue over the coming 12 months.1 Inflation in the bloc ended 2025 in line with the official 2% target, and the European Central Bank (ECB) is expected to keep rates on hold through this year.
Naturally, though, there are a number of risks and potential headwinds that could create disruption, not just in high yield but across European financial markets. There remains a high degree of unpredictability around US trade and foreign policy. A slowdown in consumer spending could hamper growth, while the rapid development of AI is creating new fault lines. Finally, the conflict in the Middle East does pose heightened risk to energy markets and global supply chains. The extent of the energy-market shock will likely depend on how long the conflict persists.
A carry-dominated market
Optically, spreads are tight and given the current stage in the cycle, may have limited scope for further tightening. Despite having already peaked, yields remain attractive and meaningfully above those available in government bonds and investment grade, providing a compelling income cushion.
The technical backdrop reinforces this outlook. Fund flows into European high yield have been running above trend, with January 2026 inflows well ahead of seasonal norms. CLO creation has been dynamic, with CLOs now buying up to 20% of their portfolios in high yield bonds.
At the same time, the European high yield market has shrunk by around 15% over the past two years as a result of upgrades to investment grade, migration from bonds to loans, and corporate cash generation.
Dispersion creates opportunity
Another relevant development for euro high yield has been the increase in dispersion – the variation in relative performance between the best-performing and worst-performing bonds.. In periods of high dispersion, issuer selection is a driver of returns and while eurozone GDP has been trending highly in recent months, this masks the emergence of distinct winners and losers across the bloc.
On the positive side, infrastructure and industrial companies stand to benefit from Germany’s fiscal expansion, while chemicals may follow with a lag once Chinese oversupply eases. European real estate, which was shunned through the rate-hiking cycle, is now showing compelling valuations as transaction volumes recover and issuers offer bondholder-friendly terms for maturity extensions.
But dispersion is also creating losers. Software companies face potential disruption from AI, and sectors with heavy exposure to supply chains remain vulnerable to tariff escalation. This uneven performance across sectors and ratings makes issuer selection – not just broad market allocation – the primary lever for generating returns.
The benefits of an active approach
Against a backdrop of tight spreads and rising dispersion, investors may need to rethink their approach to high yield credit. The current environment lends itself to an active and flexible strategy that is able to identify undervalued securities and react quickly to market developments.
One of the most appealing elements of the euro high yield market is the variety it offers – not simply in terms of credit quality but also in business resilience and valuation. For expert portfolio managers, opportunities exist lower down the capital structure, where subordinated bonds from high-rated issuers can offer high-beta exposure.
With credit spreads at historical lows, investment managers need to put even greater emphasis on identifying the individual securities that have the highest chance of generating outperformance. An intense focus on issuer selection – backed up by a robust and disciplined risk-control framework – is the key to long-term success.
A distinctive role in portfolio construction
In both fixed-income and multi-asset portfolios, euro high yield can offer valuable diversification through exposure to a part of the fixed-income universe that tends to be higher risk but is less sensitive to movements in interest rates. Since high yield bonds usually have shorter maturities than investment-grade credit or government bonds, their values fluctuate less in response to changes in monetary policy.
And while spreads remain tight, high yield bonds can still benefit from capital appreciation. Issuer-specific events such as takeovers, credit-rating upgrades or improved operational performance can drive price gains. In this way, high yield allocations can divert risk away from broad macroeconomic drivers and towards sector- or issuer-level dynamics.
At BNP Paribas Asset Management, the success of our Euro High Yield Bond strategy is based on a distinctive investment process that combines bottom-up issuer selection with top-down macroeconomic analysis. Uniquely, our portfolio managers also act as credit analysts. This allows for deep understanding of current and potential risk factors alongside the ability to react quickly to changes in the market or economic environment.
Our investment philosophy involves us unlocking value from mispricing and market inefficiencies. Our portfolio managers selectively allocating risk where we are adequately compensated for doing so. A comprehensive risk-management framework is used to screen ideas, build portfolios and review ongoing performance. We also place sustainability at the core of our approach. This helps us to manage risk as well as identify new opportunities to add value.
[1] https://www.imf.org/en/publications/weo/issues/2026/01/19/world-economic-outlook-update-january-2026
At the time of writing 19/3/2026, the Middle East conflict has not warranted any major changes to our base case macroeconomic outlook or investment recommendations. To follow our analysis of the events driving asset markets, go to Viewpoint at https://viewpoint.bnpparibas-am.com
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