Why Invest in High Yield Floating Rate Notes Today?

• By their nature, high yield floating rate notes (HY FRNs) can potentially offer investors a valuable hedge against interest rate volatility, allowing them to lock in attractive levels of yield without sacrificing the potential for attractive returns.
  
  
• They offer some of the highest yields in fixed income, coupled with very low sensitivity to changes in interest rates (duration). We believe that from today’s¹ entry point, this could result in potentially attractive returns driven by carry² alone, while in a more adverse economic slowdown, HY FRNs’ defensive features could protect against downside risks.
  
  
• Over the long term, HY FRNs have demonstrated strong and stable returns, outperforming their closest investable peer group, the senior loan market.

Understanding HY FRNs

High yield FRNs are a growing segment within the global high yield bond universe, distinguished by three key features that set them apart from traditional high yield bonds:

1. Seniority in the capital structure: HY FRNs are issued as senior debt, sitting at the top of the capital structure. In the event of a default, bondholders benefit from the highest priority of claims, often leading to higher recovery rates compared to unsecured and subordinated debt.
   
   
2. Lower volatility than traditional HY bonds: HY FRNs tend to exhibit lower volatility than fixed-rate high yield bonds. This is due to their reduced sensitivity to changes in credit spreads, measured by spread duration. Credit spreads represent the difference in yield between corporate bonds and government bonds, and tend to widen when investors perceive greater risk in corporate bonds and tighten when confidence improves. 
   
   
3. Floating coupon structure: Unlike fixed-rate bonds, HY FRNs pay coupons that adjust periodically based on standard reference rates, including EURIBOR, SONIA, and SOFR for euro, pound sterling, and US dollar issuance respectively. Coupon payments reset quarterly, adjusting with the prevailing market rates. As a result, HY FRNs have a duration range between 0 and 0.25 years. 

Why do HY FRNs make sense for investors?

1. Compelling risk-reward

Despite tight credit spreads across the fixed income landscape, all-in yields for the global HY FRN asset class remain historically elevated at 6.75%, allowing investors to lock in attractive levels of income. 

Today, HY FRNs offer some of the highest yields in fixed income, coupled with very low sensitivity to changes in interest rates (see Figure 1 overleaf). While comparable yields may be found in traditional high yield bonds or emerging market debt, these alternatives imply taking on a greater amount of interest rate risk and potential volatility in a portfolio. 

Interest rate volatility has persisted into 2025, driven by heightened political uncertainty, concerns over economic growth, and shifting expectations for monetary policy. Factors such as the Trump administration's policies, rising inflation concerns, and questions surrounding Germany’s fiscal policy have all contributed to this turbulence. In this environment, HY FRNs could provide a valuable hedge against interest rate volatility, allowing investors to lock in an attractive level of yield without sacrificing the potential for attractive returns.

Figure 1: HY FRNs vs other fixed income asset classes   

Past performance is not a guide to future performance

Source: M&G, Bloomberg, 28 February 2025. Information is subject to change and is not a guarantee of future results. 

Global HY FRN: ICE BofA Global Floating Rate High Yield 3% Constrained Index US HY: ICE BoA US High Yield Index. Europe HY: ICE BoA European High Yield Index. Short Duration HY: ICE 1-3 Year US Corporate & HY Index. EM HY: ICE BoA HY US Emerging Markets Corporate Plus Index. CMBS: ICE BoA US Fixed Rate CMBS Index. EU ABS: ICE BoA Euro Asset Backed & MBS Index. UST: ICE BoA US Treasury Index. US IG: ICE BoA US Corporate Index. Bunds: ICE BoA German Govt Index. 

2. Resilient returns under different market environments

Historically, HY FRNs have benefited from relatively elevated carry levels, averaging 5.2% (USD hedged) over the past decade. This has reinforced their resilience across various market cycles, as the steady income generated by the asset class has helped enhance returns, even during periods of price volatility. 

Figure 2 overleaf illustrates this point, demonstrating how HY FRNs have delivered stable levels of income. The carry component has helped in further boosting returns during favourable years, while also providing a cushion against the downside during periods of widening credit spreads. 

Figure 2: HY FRNs have offered a consistent high income in all market environments

Past performance is not a guide to future performance

Source: M&G, Bloomberg, 28 February 2025. Global HY FRN index (ICE BofA Global Floating Rate High Yield 3% Constrained Index).

3. Compelling return potential

Looking ahead, we believe the economy remains in a reasonable position, despite some gradual deterioration. While risks to growth persist, overall high yield corporate fundamentals have remained relatively resilient, and we do not anticipate a broad-based recession. 

We expect central banks to continue normalising monetary policy, albeit at a slower pace than in 2024, given rising inflation concerns, particularly in response to US economic policy. 

The matrix overleaf (see Figure 3) outlines different scenarios for interest rates and high yield FRN credit spreads and aims to give an indication of potential total return outcomes over a 12-month period under the realisation of any of those scenarios. From today’s entry point, under a soft economic landing (characterised by a mild interest rate-cutting cycle -- progressively lower interest rates -- and well-behaved credit spreads), HY FRNs could potentially deliver mid-single digit returns based on carry alone (see data within the green square in Figure 3).

However, if economic conditions deteriorate more than anticipated (leading to wider credit spreads and a more adverse scenario), HY FRNs remain one of the most defensive segments of the high yield market. Their structural seniority and lower market beta provide a natural buffer against downside risk, helping to mitigate capital loss. With first claim on collateral in the event of a default and strong recovery rates, HY FRNs offer a less volatile return experience, even in more challenging environments. 

Thus, whether markets follow our soft landing expectations or take a more volatile path, the portfolio remains well-positioned to deliver healthy performance in both scenarios.

Figure 3: Scenarios -- how global HY FRNs might perform over the next 12 months

Past performance is not a guide to future performance

For illustration purposes only. This is not intended to provide expectations of future returns or yield and spread levels. Analysis based on a one-year holding period, assuming a static portfolio and parallel shifts in yield curves; excludes any exposure to equities. Analysis also assumes that any moves in rates and/or spreads are one-off shocks. Assumption of a 3% default rate with an average recovery of 60% for the floating high yield market and 30% for the global fixed high yield market. 

Source: M&G based on fund and index positioning, 11 March 2025. 

¹ As at the time of writing, 11 March 2025.
² Here, carry refers to the income received by bondholders from regular coupon payments.