It would be hard to find a more passionate advocate for high-yield (HY) bonds – bonds issued by borrowers with a rating below investment grade (IG).

Donald Phillips, Head of Credit at Liontrust Asset Management, is passionate about the HY market. He has been working for the British fund management company for over eight years (which, contrary to what finews reported, does not have an office in Zurich but does distribute its products in Switzerland) and previously spent a good nine years at asset manager Baillie Gifford, naturally also in the HY division. Together with his colleague Sharmin Rahman, he also manages the Liontrust GF High Yield Bond fund launched by Liontrust in 2018, which currently has assets under management of USD 413m (as of 17/06/26)

In the lobby of an American-style hotel in Zurich, finews met with the HY advocate and endeavoured to ask him as many uncomfortable questions as possible.

Mr Phillips, the credit spreads that HY offers investors compared to government bonds have been very tight for some time now. Isn’t that a clear signal that the risks associated with high-yield bonds are not being adequately compensated?

Yes, the spreads are below average, but the yields are nonetheless attractive. The world has changed. Volatility in long-dated government bonds such as US Treasuries or UK Gilts is, in some cases, greater than in high-yield bonds. Many governments are taking on ever-increasing levels of debt, and doubts about the sustainability of that debt are growing. By contrast, most corporate balance sheets are quite robust, and the economy is growing steadily.

High-yield bonds are a sound asset class: thanks to the coupons, they generate regular, pre-determined returns – those who reinvest regularly are rewarded with good performance. Furthermore, the average credit quality in the high-yield sector is now much higher than it was in 2010, when I started. An investor recently asked me, given the strong track record, why a double-B issuer is still not considered investment grade today.

And what did you reply?

That the media should write more about how the market has developed.

When coupon payments are taken into account, high-yield bonds offer attractive long-term returns. (Chart: Liontrust)

Will the sky in the high-yield sector simply remain blue forever, despite the tight spreads, due to the factors you mentioned?

It’s not quite that simple. A key leading indicator for the default rate is the unemployment rate. However, the US labour market is currently still in good shape, as reflected in stubborn wage inflation. This remains awkward for central banks, but I’m in the camp that higher for longer rates is not necessarily a bad thing as it sustains higher yields and therefore long term returns as long as companies in general can afford the interest bill – and we think they can.. One segment currently facing apparently serious problems is private credit. When a sector expands so rapidly, it always involves risks. But I do not expect the high-yield bond market to suffer as a result.

«Our fund is essentially the antithesis of private credit.»

Has the «rubbish» that used to be commonly referred to as junk bonds simply ended up in the private market in recent years?

The term coined by Michael Milken in the 1980s is definitely no longer justified. I’m no expert on private credit, but my gut feeling tells me that there are tensions there, at least in certain areas. Our fund is actually the antithesis of that. We invest exclusively in liquid markets, and we also favour borrowers whose shares are listed. Of course, bond prices fluctuate. But the world should understand that just because there is no mark-to-market valuation for an asset, this does not mean there are no risks.

Why is this point so important to you?

Because many investors have developed an obsession with volatility – and that is a key reason why private markets have become so popular. Measures such as volatility or the maximum loss observed over a given period are not wrong, and we too try to avoid large fluctuations. But ultimately, from a bondholder’s perspective, the loss of capital – or part of it – represents the decisive risk. But we must be fair: of course, there have been – and continue to be – occasional setbacks in the high-yield market.

What comes to mind?

For example, the huge wave of issues by shale oil and gas producers in the US a good ten years ago. Many of these issuers later came under pressure due to falling energy prices. Although we do hold energy issuers in our fund, they are underweighted because we generally seek to avoid concentration risks and heavy exposure to factors such as the oil price. We do not want any single theme to dominate, and we are currently generally cautious about bonds from issuers in cyclical sectors because the premium for the associated volatility is too low.

The Liontrust Fund deviates from the benchmark, in some cases significantly, in terms of sector allocation. (Chart: Liontrust)

Does this also apply to the current wave of investment in artificial intelligence (AI)?

Yes, this could be another such case. Should this massive investment spree ever take a wrong turn – the risk-reward ratio is clearly asymmetrical. It doesn’t even have to be a default; all it takes is for investor sentiment to turn. In such a scenario, the sector will have less access to long-term capital; this is a crucial factor in our analysis of borrower creditworthiness. But lest I be misunderstood: we don’t have a crystal ball either, and unfortunately we don’t know which sector will be the next problem area. Generally speaking, however, we prefer to take on issuer-specific risk rather than thematic risk.

«Alignment of interests is at least as important to us as the covenants in the bond prospectus.»

And what are the positive selection criteria for your fund?

A key criterion for us when assessing the «G» in ESG (Environmental, Social and Governance) is that the interests of managers and owners and those of bondholders are aligned. This is not always the case in private equity, which is why we prefer listed companies as borrowers. But there are exceptions: for many years, we have been investing in the bonds of a handful of privately held companies that we know very well. These are often backed by foundations that also take a long-term view, prioritise sound finances and take their creditors seriously. For us, this alignment of interests is just as, if not more, important than the clauses in the bond prospectus, which we naturally analyse as well.

What is the biggest competition for your asset class?

In practice, we like to think of high yield as akin to defensive equity rather than to compare it against other bond segments, such as government bonds or investment grade. As long-term owners of bonds, we almost think in terms of shares, and we also closely follow the research on our listed issuers. Of course, we do not forget that in the bond market we must minimise risks rather than maximise opportunities, because the upside potential is, by the very definition of the instrument, limited.