Pictet Asset Management.
Investors often view high yield credit with caution, largely due to fears of corporate defaults. But this fear is not only overblown—it also ignores how well-compensated investors are for taking on such risks.
The risk of default is precisely why high yield bonds offer a higher return than safer fixed income assets. According to research from Pictet Asset Management, these returns have historically more than offset losses from defaults. Since 2000, European high yield credit has posted an annualised return of 5.2%, significantly higher than the 2.8% offered by German government bonds. This premium has not come at the cost of outsized losses: the average default rate has been just 1.3% per year, resulting in a modest average annual loss of 0.7%.
Ironically, many of the same investors who shy away from high yield bonds readily invest in equities, which experience their own form of “default” more frequently and with greater severity. Equities don’t formally default, but companies can and do fail. Using a proxy of a 70% stock price drop followed by removal from the MSCI Europe Index, Pictet calculates an equity “default” rate of 5.17% annually since 2005—more than double that of high yield credit.
On a risk-adjusted basis, high yield credit becomes even more attractive. With annualised volatility of 10.7% and a maximum drawdown of 37%, it is significantly less volatile than European equities, which have a volatility of 18.2% and a drawdown of 55%. And unlike dividends, which can be cut or suspended, high yield bonds offer more predictable income through coupon payments. Additionally, bond prices tend to recover toward face value as they near maturity—a phenomenon known as the “pull to par”—providing another mechanism for capital recovery that equities lack.
What’s more, high yield credit has demonstrated resilience in market recoveries. Following market downturns, it has often matched or outperformed equities during subsequent rebounds. This combination of lower default rates, strong relative returns, and defensive characteristics makes high yield credit a compelling long-term investment option.
Despite these facts, investor sentiment often overlooks the favourable fundamentals of high yield credit. This asset class remains underappreciated, not because of its actual performance, but due to misconceptions about default risk. When defaults are viewed in the appropriate context—especially when compared to equity risks—the case for high yield becomes clear.
For investors willing to adopt a medium- to long-term view, European high yield credit offers a compelling proposition. The returns more than justify the risks, especially when weighed against so-called “risk-free” government bonds and volatile equities. Rather than being something to fear, credit defaults—when properly understood—should be seen as part of a broader risk-reward dynamic that continues to favour high yield.
