Rebalancing Toward Fixed Income: High-Yield Bonds as a Superior Risk-Adjusted Return Opportunity in 2025

The investment landscape in 2025 is marked by a stark divergence in risk-adjusted returns between asset classes. As equity valuations stretch to historically elevated levels, high-yield bonds have emerged as a compelling alternative for investors seeking to rebalance portfolios toward fixed income. With yields exceeding 7% globally, these bonds offer not only attractive income but also superior resilience during market turbulence, making them a cornerstone for optimizing risk-adjusted returns in an uncertain macroeconomic environment [1].

The Case for High-Yield Bonds: Risk-Adjusted Returns and Resilience

Historical data underscores the superiority of high-yield bonds over equities in terms of risk-adjusted performance. Since 2001, global high-yield bonds have consistently outperformed equities in both absolute returns and volatility metrics, with a Sharpe ratio that remains significantly higher [1]. This edge is amplified by the bonds’ ability to weather downturns with smaller drawdowns—averaging 11% compared to equities’ 26%—and faster recoveries, typically rebounding in under eight months versus nearly 19 months for equities [1]. These characteristics are critical in an era where central bank policies and economic volatility remain unpredictable.

The current yield environment further strengthens the case. With global high-yield bonds yielding over 7%, investors are positioned to capitalize on a historical trend: periods with yields between 7-8% have delivered positive returns in 90% of 12-month windows since 1987 [1]. This yield premium is particularly compelling against the backdrop of overvalued equities, where price-to-earnings multiples have outpaced earnings growth, eroding the margin of safety for equity investors [1].

Credit Fundamentals and Valuation Advantages

Beyond yield, the quality of the high-yield market has improved markedly. The proportion of BB-rated bonds has risen to over 50% of the global high-yield index, while the share of speculative-grade B- and CCC-rated bonds has declined [1]. This shift reflects stronger corporate balance sheets and lower default risks, bolstering the case for high-yield bonds as a defensive asset class.

Moreover, the yield differential between high-yield bonds and equities has widened to a 4-percentage-point gap, a level that historically signals undervaluation for bonds [1]. This spread offers a buffer against potential defaults and provides a compelling income stream that equities, with their lower dividend yields and higher volatility, cannot match.

Strategic Implications for Portfolio Rebalancing

For investors, the case for rebalancing toward high-yield bonds is clear. The combination of attractive yields, improved credit fundamentals, and superior risk-adjusted returns positions these bonds as a superior alternative to equities in 2025. While U.S. high-yield markets face tight valuations and limited excess returns over Treasuries [5], the global high-yield market remains a more compelling opportunity, offering both income and downside protection [1].

However, investors must remain selective, focusing on higher-quality segments of the market to mitigate idiosyncratic risks. The improved credit profile of the high-yield index suggests that even in a downturn, the sector’s resilience will outperform equities, making it a strategic anchor for portfolios seeking stability without sacrificing returns.

Conclusion

As the investment world grapples with the challenges of a post-pandemic economy and shifting monetary policies, high-yield bonds stand out as a superior risk-adjusted return opportunity. Their historical performance, current yield levels, and improved credit quality make them an essential component of a rebalanced portfolio. For investors prioritizing resilience and income, the time to act is now.

Source:
[1] The Case for High Yield vs. Equities,
https://www.pgim.com/us/en/intermediary/insights/thought-leadership/the-case-for-high-yield-vs--equities