High yield bonds — also called "junk bonds" or sub-investment grade bonds — are corporate debt securities rated below BBB-/Baa3 by the major credit rating agencies. The lower rating reflects a higher probability of default than investment grade issuers, and investors demand higher yields to compensate. Over full economic cycles, high yield bonds have historically offered returns closer to equities than to government bonds, but with different risk characteristics that make them a useful diversifier within a sophisticated portfolio.
Capital is at risk. High yield bonds carry significant default risk and can lose substantial value during recessions or credit crises. This guide is for information only and does not constitute regulated investment advice.
The Rating Spectrum
High yield runs from BB+ (the highest sub-investment grade rating, just below investment grade BBB-) down through B to CCC and below. The risk profile varies significantly across this range:
BB-rated bonds (often called "double-B") are the highest quality within high yield. Many BB issuers are companies that were previously investment grade and have been downgraded, or companies in transition to investment grade. BB default rates are typically low — often below 1% per annum in normal economic conditions. Institutional investors including many high yield funds and some investment grade mandates (with modest high yield allowances) can hold BB bonds.
B-rated bonds carry meaningfully higher default risk than BB, typically 2–5% per annum in normal conditions and significantly higher in recessions. The compensation is a substantially higher yield. B-rated issuers are often leveraged buyout companies owned by private equity, or capital-intensive businesses with significant fixed charges.
CCC-rated bonds are highly speculative: default rates can exceed 15–20% per annum during recessions. They offer the highest yields — often 10–20% or above — but the volatility is extreme and the recovery in a default may be very limited. CCC exposure is typically reserved for specialist high yield managers with dedicated workout and restructuring capabilities.
Why High Yield Historically Compensates for Default Risk
The core logic of high yield investing is that the yield premium over investment grade bonds more than compensates for expected defaults, providing a positive return over time even accounting for losses from defaulted bonds. This spread compensation has varied considerably:
- In tight credit conditions, HY spreads may be 250–350 basis points over comparable government bonds
- At the depths of the 2008 financial crisis, HY spreads reached 2,000 basis points — implying the market was pricing in extraordinary default rates
- Through most market conditions, the realised default rate has been below the worst level implied by spreads at their widest, meaning mean-reversion buying after credit crises has historically been highly profitable
Historical default rates (US market, Moody's data over multi-decade periods): average annual default rate for speculative grade issuers is approximately 3–4% in normal conditions, rising to 10–14% during severe downturns (2001–2002, 2008–2009). Recovery on defaulted bonds varies by seniority — senior secured bonds recover 50–70 cents on the dollar on average; senior unsecured 35–45 cents; subordinated bonds much less.
Fallen Angels
A fallen angel is an investment grade bond downgraded to high yield. Fallen angels are often large, well-known companies — Ford, GE Capital, Marks & Spencer, various energy companies — that have experienced financial deterioration. They create a specific opportunity:
When a bond is downgraded below BBB-, investment grade funds are forced to sell (by mandate), often regardless of price. This forced selling can push the fallen angel's price below fair value for a brief period. Specialist fallen angel strategies — and broad high yield funds — that can act quickly have historically generated excess returns by purchasing these bonds during the period of forced selling.
BlackRock, VanEck and several active managers have dedicated fallen angel strategies or ETFs. The iShares Fallen Angels High Yield Bond ETF (FALN) provides systematic exposure to this sub-segment of the US market.
US vs European High Yield Market
US high yield is the world's largest and most liquid sub-investment grade bond market, with over $1.5 trillion outstanding. It is characterised by:
- A diverse range of sectors, including significant energy, healthcare and telecoms issuers
- More covenant-lite structures in recent years
- Developed secondary market liquidity, particularly in the BB and B tier
- Historically higher average yields than European equivalents reflecting different average leverage and sector mix
European high yield is smaller (approximately €400–500 billion outstanding as of 2025) but has grown substantially over the past decade. Key differences:
- Shorter average duration than US HY (European issuers have typically issued shorter-dated bonds)
- Greater proportion of senior secured structures, which improves average recovery in defaults
- Lower average leverage ratios than US peers
- Currency risk for UK investors (EUR/GBP or EUR/USD depending on denomination of the fund)
For UK investors, currency-hedged access to both markets is available through funds and ETFs. Euro-denominated European HY carries currency risk unless hedged; USD HY carries dollar risk unless hedged.
High Yield in a Rising Rate Environment
The relationship between high yield bonds and interest rates is more complex than for investment grade:
Rate sensitivity is lower because HY bonds have shorter durations (typically 3–5 years) and the coupon rate is higher, reducing duration naturally. A 100 basis point rate rise causes less price damage to a HY bond than to a 10-year gilt.
Spread compression can offset rate rises: in periods when rates rise because of strong economic growth (rather than inflation-driven panic), high yield spreads often tighten because credit quality improves in strong economic conditions. The net effect on HY total return can be positive even as government bond prices fall.
The 2022 experience: in 2022, both rate rises and spread widening occurred simultaneously (a stagflationary scenario), producing negative total returns for most HY markets. The European HY market was particularly affected by the Russia-Ukraine war's impact on European energy costs and the associated economic uncertainty. However, HY returns in 2022 were broadly less negative than global equities.
High Yield ETFs vs Active Funds
ETFs tracking HY indices include:
- iShares £ High Yield Corp Bond UCITS ETF (ticker: HYLD or similar): sterling-denominated HY exposure, UK-focused
- iShares USD High Yield Corp Bond UCITS ETF: dollar HY, typically hedged to sterling in the UCITS version
- iShares $ High Yield Corp Bond ESG UCITS ETF: ESG-screened HY exposure
- Xtrackers EUR High Yield Corp Bond UCITS ETF: European HY in euros
ETF advantages: low cost (typically 0.20–0.50% annual charges), daily liquidity, diversification, systematic credit exposure.
ETF limitations: you own the entire index, including the weakest CCC credits. ETFs cannot avoid fallen angels during forced selling, cannot position away from deteriorating credits ahead of downgrades, and cannot participate selectively in new issues.
Active HY funds provide portfolio manager discretion to:
- Underweight deteriorating credits before default
- Overweight sectors where spreads are more attractive
- Participate in new issue concessions
- Manage duration tactically
- Avoid the most covenant-lite, over-leveraged structures
The empirical evidence on active HY management is more supportive than in investment grade, because:
- Information asymmetry is higher in HY (smaller issuers, less analyst coverage)
- Credit selection has more impact on outcomes when default risk is material
- Manager access to primary market new issues can be advantageous
Fee comparison is critical: HY active funds charge 0.5–1.0% or more, which must be justified by credit alpha net of all fees.
Liquidity Considerations
High yield bond secondary market liquidity is meaningfully lower than government bonds and investment grade bonds. During periods of stress (Q4 2018, March 2020, Q4 2022), bid-offer spreads in HY bonds widen considerably and large sellers face significant market impact. Open-ended HY funds with daily liquidity can face pressure during redemption periods as managers are forced to sell bonds at unfavourable prices.
Investors should assess a fund's liquidity management policies, the concentration of the portfolio in less liquid instruments, and the historical experience of the fund during redemption pressure.
Portfolio Role and Sizing
High yield bonds sit between investment grade bonds and equities in the risk spectrum. They are typically included in:
- A credit allocation within a multi-asset portfolio (alongside IG and emerging market debt)
- An income-focused portfolio alongside other yield-generating instruments
- An alternatives sleeve for investors who do not access pure equity but want higher return potential than IG
Typical institutional allocations to HY are 5–15% of total portfolio, with sizing reflecting the credit quality of the portfolio and the investor's tolerance for mark-to-market volatility.
Investments can fall as well as rise. Credit conditions change and previous default rates are not a guarantee of future defaults. Rules and tax treatment change. Seek regulated professional advice.
How Global Investments Can Help
Our fixed income team can help you assess the appropriate HY allocation within your portfolio, select between ETF and active fund approaches, manage currency risk across USD and EUR HY markets, and monitor credit quality deterioration that may warrant reducing exposure before a credit cycle turns. We also advise on the interaction between high yield and equity exposure within a multi-asset portfolio, to avoid unintended correlation in periods of market stress.
Contact us to discuss high yield and credit allocation.
This guide is for general information only and does not constitute financial advice or a personal recommendation. The value of investments can fall as well as rise and you may get back less than you invest. Past performance is not a guide to future returns. Tax rules, investment regulations, and the availability of specific investment vehicles change — always verify current rules and seek advice from a qualified independent financial adviser before making any investment decisions.