Not just junk: Targeting quality and liquidity in high yield

This article was written by Amine Khanjar, Quantitative Researcher at Bloomberg. 

High Yield (HY) bonds have often been perceived as speculative, volatile instruments better suited for opportunistic trades than long-term allocation. While the asset class carries higher risk compared to other core fixed income segments, there is a growing body of empirical evidence showing how HY warrants consideration in long term strategic asset allocation. When thoughtfully integrated into diversified portfolios, sub-investment-grade credit exposure may enhance return potential while also delivering income stability and diversification benefits that are attractive relative to other fixed income sectors throughout the business cycle.

At the core of HY’s appeal is its structural yield advantage. Over long horizons, yield has remained a reliable predictor of total returns in fixed income. Decades of market data reveal that high yield bonds have delivered long-term returns that approach those of equity markets but with lower volatility. This attractive risk-return profile has made high yield a valuable tool to enhance portfolio efficiency.

Highlighted in the figure below, High Yield had a Sharpe ratio of 0.48 over the 2000-2025 period above both Treasuries (0.32) and equities (0.35), underscoring its efficient risk-adjusted return profile.

Additionally, HY bonds exhibit a relatively low correlation with core bond aggregates, offering meaningful diversification in fixed-income allocations. This becomes particularly valuable in environments of rising rates or inflationary pressure, where traditional duration-heavy assets may struggle.

But extracting value from the high yield market goes past broad exposure. The asset class is highly heterogeneous, spanning a vast credit quality spectrum—from BB-rated “fallen angels” just below investment grade, to deeply distressed CCC-rated names on the verge of default. Liquidity, too, varies significantly. A large segment of the HY universe trades infrequently, with wide bid-ask spreads and low institutional ownership, increasing transaction costs and hampering execution in volatile markets.

Both credit quality and liquidity have tended to correlate positively with issuer size. Bonds from larger HY issuers are generally higher-rated and supported by stronger balance sheets. Over the past 25 years, the top 100 high yield issuers by market value have demonstrated leverage ratios approximately 0.7x lower than the broader universe and interest coverage ratios nearly 1.2x higher. Their securities are more liquid, more actively traded, and more widely held by institutional managers. This translates into tighter spreads, and lower frictional costs as Figure 2 shows.

Notably, portfolios tilted toward the largest issuers inherently shift toward the BB rating bucket, which has historically offered the most attractive risk-adjusted performance in high yield. BB-rated bonds have averaged 6.7% annual returns over the past 25 years, with significantly lower volatility than their lower-rated counterparts. These securities can offer a  balance of yield and credit stability—earning a strong carry profile while avoiding some of the sharp drawdowns that plague the lower reaches of the HY spectrum. In contrast, CCC and CC-rated bonds, while boasting higher headline yields, have underperformed on a risk-adjusted basis. With realized annual returns of 5.9% and 5.6% respectively, these bonds introduce elevated default risk and have historically experienced the deepest losses in market downturns.

The contribution of income from these higher-quality HY issuers is not insignificant. Coupons on BB bonds have typically been 300–400 basis points above Treasuries—thus, potentially providing a consistent income stream and mitigating against price volatility. Moreover, these bonds tend to be senior in the capital structure and offer stronger covenant protection, further reinforcing their relative resilience.

Recently, the increasing prevalence of highly indebted issuers—and the rising concentration of sectors such as energy and telecom—has raised questions about the systemic risks embedded in market-value weighted indices. Equal-weighting issuers can ensure broader diversification and reduce idiosyncratic risks associated with company-specific events, all while maintaining the core characteristics that make market value weighted indices attractive for institutional investors.

Figure 4 below shows how equal weighting the highest coupon bonds from the top 100 issuers (Bloomberg US HY Top100 Quality Select Equal Weighted Index) could result in 65 bps outperformance vs the broad Bloomberg HY index since 2007 with a decrease in volatility.

In conclusion, the high yield market can offer opportunities beyond surface-level yield. When approached with analytical rigor, attention to liquidity, and thoughtful construction techniques, HY bonds can offer cornerstone potential for long-term strategic allocations. Whether through tilts toward larger, higher-quality issuers, screening on liquidity or through the adoption of alternative weighting methodologies, investors can tap into HY’s potential while sidestepping its pitfalls.

• F/m Investments has launched the F/M High Yield 100 ETF tracking the Bloomberg U.S. High Yield Top 100 Quality Select Equal Weighted Index (HYTOP100) under the ticker ZTOP.