US high yield: Where convexity meets quality

August 5, 2025

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A focus on quality, convexity and credit selection is key to navigating risk and generating returns in US high yield, argues John Colantuoni.

We are well past the halfway point of 2025 and the Trump administration’s reform agenda is in full swing. However, given concerns around tariffs and growing geopolitical tensions, questions have been raised about the reliability and stability of the world’s biggest investment market.

Such fears have been overplayed, in our view. Underlying data depicts an economy that remains resilient with a 2% annualized real GDP growth - consistent with its 10-year trend.¹ Meanwhile, credit markets are functioning well, with low defaults (Figure 1), a strong technical environment and tight spreads.²

While tight spreads in US high yield may imply little upside, careful security selection and a focus on balance sheet strength - particularly in sectors under pressure – can be useful tools for generating alpha. Structural features such as convexity [see footnote 3 for definition] can also be critical tools for managing risk and enhancing potential returns.

Discipline and detail

Higher US interest rates have deterred some non-USD investors due to elevated hedging costs. However, since these costs reset on a rolling three-month basis, they could decline quickly if the Federal Reserve begins cutting rates - a scenario we view as a possibility, particularly given the rally at the front end of the Treasury curve - notably in the five-year segment. While rate cuts typically favour investment grade, they also benefit high yield, especially lower-priced bonds, which offers capital gain potential in a declining rate environment.

Unlike investment grade, where sector allocation plays a larger role, we believe high yield investing should be driven primarily by bottom-up credit selection. This helps mitigate exposure to sector-specific bubbles - such as the 2015/16 US high yield energy crisis - which can lead to default spikes and outsized losses for investors with concentrated positions. Instead, we focus on issuers with strong balance sheets, attractive yields and low leverage to build more resilient portfolios.

We have applied this approach to the healthcare sector, which has faced pressure amid uncertainty around potential Medicaid cuts. Despite broader sector weakness, we believe good value can be found on a selective basis, which has resulted in solid performance.

Another possible way to enhance upside is through allocating to short-dated, USD-denominated bonds currently trading below par but that offer favourable return asymmetry. While yields may not seem compelling at current spreads, their short duration and high likelihood of being called 5-6 months before maturity create an attractive opportunity.

In a falling rate environment, these bonds can provide a convex return profile, adding value without significantly increasing risk. Such an approach seeks to capture upside from pull-to-par effects and early calls while maintaining a conservative risk profile thanks to limited duration and downside exposure. In a tight spread environment, we believe a higher-quality bias is appropriate, seeking limited value in lower-rated issuers.

Staying defensive

Given uncertainty around the policy and broader macro environment, we have adopted a more defensive stance across our portfolios, increasing exposure to sectors such as aircraft leasing, software, telecom infrastructure (wireline) and other non-cyclicals. In our view, these areas are largely insulated from tariff risks, offer stable recurring cash flows and benefit from secular tailwinds like artificial intelligence adoption and industry consolidation.

As a result of our efforts to limit downside risk, we believe our portfolios are well-positioned to benefit from any future spread widening. Our underweight stance in cyclicals reflects ongoing uncertainty around the impact of recent tax and spending legislation. At the same time, we remain cautious on energy, where we believe current valuations do not adequately compensate for risks such as fragile infrastructure.

Opportunistic yet defensive

In a market shaped by strong underlying economic fundamentals but clouded by policy uncertainty and tight spreads, high yield investing requires a disciplined and selective approach. While the Trump administration’s policies have yet to significantly disrupt sector dynamics, good credit selection can unlock opportunities, even in areas under pressure such as healthcare.

At the same time, keeping a close eye on convexity and short-duration securities could become increasingly important as investors navigate a maturing credit cycle. With spreads offering limited room for compression, but volatility likely to reappear periodically, we remain defensively positioned but with room to take advantage of any spread widening events. In our view, there is still plenty of value to be found in US high yield for investors willing to dig deep, remain selective and maintain credit discipline.

References

1. Trading Economics, US GDP Annual Growth Rate, as of March 2025.
2. ICE Index Platform, as of 29th July 2025. ICE BofA US Cash Pay High Yield Index (J0A0).
3. Convexity measures the relationship between a bond’s price and yield as interest rates change. Most bonds have positive convexity, meaning the increase in a bond’s price is greater than the decrease in interest rates (in percentage terms) and vice versa.

 

This material is not intended to be relied upon as a forecast, research, or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed by Muzinich & Co are as of August 2025 and may change without notice.

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Index descriptions

JUC4 - The ICE BofA  BB-B US Cash Pay High Yield Constrained Index contains all securities in the ICE BofA  US Cash Pay High Yield Index (J0A0) rated BB1 through B3, based on an average of Moody's, S&P and Fitch, but caps issuer exposure at 2%.

HE00 - The ICE BofA Euro High Yield Index tracks the performance of EUR dominated below investment grade corporate debt publicly issued in the euro domestic or eurobond markets. Qualifying securities must have a below investment grade rating (based on an average of Moody’s, S&P and Fitch), at least 18 months to final maturity at the time of issuance, at least one year remaining term to final maturity, a fixed coupon schedule and a minimum amount outstanding of EUR 250 million.  

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