Return of the roll-down

May 6, 2025

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In his latest column on the key developments, themes and opportunities in credit markets, Ian Horn examines what steeper yield curves mean for investors.

Steepening yield curves are giving credit investors the opportunity to capture an additional potential source of return, known as ‘roll-down’. This is a product of upward sloping yield curves - something we associate with ‘normal’ credit markets.

As an example, when yield curves are flat, a bond yielding 5% today would continue to yield 5% until maturity. The owner’s return distribution would be 5% each year until maturity. However, when yield curves are upwardly sloping, the yield of a bond will fall as it trades closer to maturity. This should be expected in a normal market, where longer-dated bonds should command a greater risk premium than shorter-dated bonds.

As the yield falls, there is upward pressure on the price of the bond, resulting in higher annual returns earlier in the bond’s life. The return distribution is therefore not uniform over time, but front-loaded. We often refer to this as ‘taking the total return up front’.

This can be an argument for rotating out of bonds before maturity, as a larger proportion of a bond’s total return can be achieved earlier in the bond’s life.

Roll down, roll down

The key to this roll-down opportunity is the steepness of yield curves. The steeper the curve, the faster yields fall as maturity approaches. Thus, the more performance is realised early, as described above. Yield curve shapes can vary significantly by issuer, sector, region and rating, but the steepest yield curves tend to offer the biggest roll-down opportunity.

To give a measure of curve steepness, government bond investors will often look at the ‘2s-10s’ spread. This is the difference between yields on a 2-year bond and a 10-year bond from the same sovereign issuer. Figure 1 shows the current ‘2s-10s’ and ‘2s-5s’ spread in German government bonds. We can see that the Bund curve is now relatively steep by these measures. European Central Bank rate cuts have helped the front-end to fall, whilst expectations of higher future issuance have kept the long-end elevated.

Steeper corporate curves

Figure 2 illustrates the yield differential between 1-3 year and 7-10 year EUR corporate bonds over time, split by single-A and BBB-rated issues. This allows us to generate something akin to the sovereign ‘2s-10s’ measure, but for corporate bonds. A rising differential indicates a steeper yield curve.

Another way to see this is change is to simply plot corporate yield curves today and compare them to 12-months ago. Figure 3 shows this for BBB-rated EUR issues.

Timely exit

For short-duration strategies, where yield is typically the key driver of performance, roll-down can be a helpful additional source of return. Capturing it requires managers to exit bonds before maturity – holding them for the period where total returns are largest, before selling as the yield and return potential declines.

Whilst trading costs of selling before maturity must be considered, upward-sloping yield curves can allow managers to capture additional returns by rotating their holdings in the months and quarters ahead of maturity, something that wasn’t possible in the recent era of flat and inverted yield curves.

 

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 May 2025, and may change without notice.

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Index descriptions

ER31 – The ICE BofA 1-3 Year Single-A Euro Corporate Index is a subset of ICE BofA Euro Corporate Index including all securities with a remaining term to final maturity less than 3 years and rated A1 through A3, inclusive.

ER34 - The ICE BofA 7-10 Year Single-A Euro Corporate Index is a subset of ICE BofA Euro Corporate Index including all securities with a remaining term to final maturity greater than or equal to 7 years and less than 10 years and rated A1 through A2, inclusive.

ER41 - The ICE BofA 1-3 Year BBB Euro Corporate Index is a subset of ICE BofA Euro Corporate Index including all securities with a remaining term to final maturity less than 3 years and rated BBB1 through BBB3, inclusive.

ER42 - The ICE BofA 3-5 Year BBB Euro Corporate Index is a subset of ICE BofA Euro Corporate Index, including all securities with a remaining term to final maturity of 3 to 5 years, and rated BBB1 through BBB3, inclusive.

ER43 - The ICE BofA 5-7 Year BBB Euro Corporate Index is a subset of ICE BofA Euro Corporate Index, including all securities with a remaining term to final maturity of 5 to 7 years, and rated BBB1 through BBB3, inclusive.

ER44 - The ICE BofA 7-10 Year BBB Euro Corporate Index is a subset of ICE BofA Euro Corporate Index, including all securities with a remaining term to final maturity of 7 to 10 years, and rated BBB1 through BBB3, inclusive.

ER49 - The ICE BofA 10+ Year BBB Euro Corporate Index is a subset of ICE BofA Euro Corporate Index, including all securities with a remaining term to final maturity of more than 10 years, and rated BBB1 through BBB3, inclusive.

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