Euro HY returns show fading demand for weaker credits

As we approach the end of 2025, we have been taking stock of the key themes of the year and any lessons we can take from them. It has been a strong year for European high yield (HY) credit, with solid performance for the index as a whole and average yields compressed by around 40bp over the course of the year. However, this was largely a reflection of strong demand for higher quality credits, while there was a notable drop off in demand further down the quality spectrum.

The latter half of 2025 has brought a divergence in performance between BB and single B-rated credit (see Exhibit 1). While BB and B rated HY bonds generally tracked one another in the first half of the year, the second half saw a bifurcation in demand as BB yields continued to grind tighter, while Bs sold off and are set to close the year some 60bp wider than where they started.

While there is no single catalyst we can point to that drove this shift, we believe the trend demonstrates a reasonably high level of risk-on sentiment from investors, but with a clear ceiling, which should continue to assuage fears of a market overheating. 

Performance has also varied dramatically by sector, with energy the winner based on total returns year-to-date (see Exhibit 2). This partly reflects the flight to quality within Euro HY as there is a prevalence of higher-rated issuers in this sector, and performance was also bolstered by an upswing in refining margins in North-Western Europe, which strengthened cash generation and sentiment for HY energy issuers. We also saw some of the worst performing sectors from previous years rising to the top of the table in 2025, with both real estate and autos outperforming the wider index YTD as they recovered some of their prior losses.

Telecoms performed well as it benefited from a reduction in capex intensity after some years of heavier investment, and stable cashflows. Retail was a mixed bag with pockets of strength in some regions (e.g. Spain, Italy) and robust demand for goods and services that were either non-discretionary or high up the priority list for consumers (e.g. travel, gyms, beauty). However, other consumer discretionary sectors faced subdued demand, which put strain on lower-rated HY issuers.

Among the underperformers were the building materials and construction sectors, which were impacted by persistent challenging conditions and weak sentiment facing Europe’s industrial sectors. Chemicals stood out as the clear loser with total returns of -2.8% YTD. The sector has faced multiple ongoing challenges such as elevated energy costs, weak end-market demand, global overcapacity and increased competition from imports from Asia.

As we saw with autos and real estate, looking at the worst performers from previous years can be a good way to identify next year’s winner, as yields may rebalance and bonds retrace losses that were perhaps overdone. However, the chemicals sector’s troubles look far from over. We can expect plenty more negative headlines in the new year, with all eyes on two of Europe’s largest HY issuers, Ineos Group and Ineos Quattro, which have faced sharp bond sell-offs and multiple rating downgrades, and owner Jim Ratcliffe has been lobbying for European politicians to intervene to “save the sector”. 

For now, as is the case in other sectors, our focus is on higher quality and resilient issuers in the European HY market. As active managers, we are always on the lookout for idiosyncratic opportunities to pick up yield while, most importantly, avoiding losers. Spreads are well below their medium-term averages, so opportunities for large capital gains in credit would appear to be limited. For our view on some of the key trends that will drive credit markets next year, see our annual outlook: The TwentyFour 7: Seven questions that could define 2026 for fixed income.