Managing Defaults in a High Yield Portfolio

How Frequently Do Issuers Default?

At the broad market index level, historically, based on Moody’s data, the median annual default from the start of 1996 to the end of June 2025 for the high-yield market was 3.41%. We use the median here rather than the average due to the large skew in the distribution of defaults caused by spikes during crises. In calmer economic periods, the default rate can drop to below 2%, while during crises such as 2008, the telecoms crash around 2000, and the 2015/2016 commodity downturn, defaults can temporarily spike to 8% and above.

Recovery Rates: What You Get Back

The recovery rate refers to the percentage of face value investors recoup after a default. Historically, the average recovery rate for senior unsecured bonds in the high-yield market has been around 40%. Based on Moody’s data, in the last 5-years to end June 2025 - a period including the covid bull market and 2022 market volatility - according to Moody’s, senior unsecured debt has recovered around 35.63 on the dollar, while secured and subordinated debt have recovered around 58.91 and 16.48 respectively.

Also, the economic backdrop impacts recovery rates. During the market downturn caused by the inflation spike in 2022, recovery rates on senior unsecured bonds were as low as 22.85 on the dollar. While during the bull market that we saw during covid, supported by historically low interest rates, we saw recovery rates on senior unsecured bonds reach as high as 55.34.

How Investors are More than Compensated for Defaults

Assuming a diversified basket of high yield bonds is held, the spread on the high yield market more than compensates for the expected loss given default.

Loss given default = default rate x (1-the recovery rate)

Assuming an average recovery rate of 40% and using the historical median default rate from above of 3.41%. This implies an average loss given default of around 2.05% per annum at the index level.

In the long run (since end 1996 to end June 2025) the median spread on the ICE US high yield index has been 482bps. We use the median to both adjust for the skew in the distribution caused by crises, and to be consistent with our use of the median for defaults. At a very simplistic level this shows that investors are more than compensated for defaults, by around 277bps in the long run. Of note this equates to the excess return on the ICE US high yield index over the same time period (end 1996 to end June 2025) of 277bps. The key here is, to be properly compensated a diversified basket of high yield bonds is required.

Past performance is not an indication of future returns

The Worst-Case Scenario – Panic & Forced Selling

Defaults can spark panic selling, usually among less experienced investors or funds that are forced to sell. This can temporarily drive prices to well below expected recovery. Panic and forced selling is very detrimental to long term returns as it leads to a permanent loss of capital.

The below is an example of a recent restructuring and the impact that panic or forced selling would have had. In early 2024 investors began to worry that Intrum would default – panic ensued with the price falling to around 60-70. If you had panicked or were a forced seller you crystalised a loss. However, by understanding the risks and having an appropriate risk sizing prior to the panic, the bond could have been held through the volatility, ultimately achieving a recovery of 90 in mid-2025.

How Active Management Can Help With Defaults

As high-yield investing is built on the premise that some defaults will happen, actively managed strategies can help optimise the portfolio to decrease the impact of defaults. An active high-yield fund can help manage defaults via:

• Tilting the portfolio towards higher quality credits, namely BB credits

• Credit analysis to avoid issuers with weak balance sheets and deteriorating fundamentals

• Deep analysis of structure, covenants and collateral to improve the overall expected recovery rate if a default does occur

• Adjusting issuer risk exposure based on risk and expected recovery. This compares to an index which weights towards issuers with the largest amount of notional debt

• Managing through any default scenarios to maximise recovery and identify mispriced opportunities

Defaults are part of the high-yield bond market by design. Investors are compensated for this risk, assuming they have sufficient diversification. With an active approach—focusing on tilting the portfolio towards higher quality, disciplined credit analysis and risk sizing, and patience—defaults can often be navigated without lasting damage. In fact, for active managers who understand the process, periods of stress and volatility can create attractive opportunities.

Important Information

The value of investments and the income derived from them can fall as well as rise, and past performance is no indicator of future performance. Investment products may be subject to investment risks involving, but not limited to, possible loss of all or part of the principal invested. This document does not constitute and shall not be construed as a prospectus, advertisement, public offering or placement of, nor a recommendation to buy, sell, hold or solicit, any investment, security, other financial instrument or other product or service. It is not intended to be a final representation of the terms and conditions of any investment, security, other financial instrument or other product or service. This document is for general information only and is not intended as investment advice or any other specific recommendation as to any particular course of action or inaction. The information in this document does not take into account the specific investment objectives, financial situation or particular needs of the recipient. You should seek your own professional advice suitable to your particular circumstances prior to making any investment or if you are in doubt as to the information in this document. Although information in this document has been obtained from sources believed to be reliable, no member of the EFG group represents or warrants its accuracy, and such information may be incomplete or condensed. Any opinions in this document are subject to change without notice. This document may contain personal opinions which do not necessarily reflect the position of any member of the EFG group. To the fullest extent permissible by law, no member of the EFG group shall be responsible for the consequences of any errors or omissions herein, or reliance upon any opinion or statement contained herein, and each member of the EFG group expressly disclaims any liability, including (without limitation) liability for incidental or consequential damages, arising from the same or resulting from any action or inaction on the part of the recipient in reliance on this document. The availability of this document in any jurisdiction or country may be contrary to local law or regulation and persons who come into possession of this document should inform themselves of and observe any restrictions. This document may not be reproduced, disclosed or distributed (in whole or in part) to any other person without prior written permission from an authorised member of the EFG group. This document has been produced by EFG Asset Management (UK) Limited for use by the EFG group and the worldwide subsidiaries and affiliates within the EFG group. EFG Asset Management (UK) Limited is authorised and regulated by the UK Financial Conduct Authority, registered no. 7389746. Registered address: EFG Asset Management (UK) Limited, Park House, 116 Park Street, London W1K 6AP, United Kingdom, telephone +44 (0)20 7491 9111.