Corporate bonds: a compelling choice despite tight spreads

The additional yield offered by corporate bonds over government bonds has narrowed further this year, raising the question of whether an investment in corporate bonds still makes sense. In our view, the answer is yes – for various reasons.

European IG corporate bonds have outperformed government bonds in recent weeks and months. This has been mainly due to the fact that the peace process in Ukraine seems to be gathering momentum, despite ongoing difficulties. Against this backdrop, hopes for an end to the war and the associated new economic momentum in Europe are rising. In addition, the yields on corporate bonds are currently fluctuating less than those of their government counterparts, as credit spreads correlate negatively with government bond yields in the long term. One aspect that should not be underestimated in this context is that many high-quality borrowers in the investment grade segment operate globally, and therefore offer a certain degree of protection against country-specific risks, as well as better diversification compared to government bonds.

Strong fundamentals
Another factor that justifies the current narrow spreads is strong fundamentals. Unlike many countries that are struggling with sharply rising debt ratios, corporations have often cleaned up their balance sheets in recent years and are in a solid position. The average net debt of high-quality European companies (excluding British issuers) is a healthy 2.7x in relation to EBITDA (earnings before interest, tax, depreciation and amortisation). The interest coverage ratio – i.e., how often companies can pay their interest from their profits – is a robust 13x. In terms of EBITDA margins, European IG issuers are currently showing the strongest growth on record.

All of this is also reflected in improved credit quality: recent credit rating upgrades by rating agencies have exceeded downgrades. The share of the lowest investment grade rating, BBB-, in the corresponding global corporate bond index has steadily declined in recent years.

High demand, low supply
In addition to corporate fundamentals, technical factors have also contributed to the recent positive trend in corporate bonds: High inflows into euro-denominated IG corporate bonds have contrasted with a recent decline in issuance activity. This trend is likely to continue for the rest of the year, and the net issuance volume in 2025 is expected to be lower than last year (see chart). Many companies are holding back on investments as well as on mergers and acquisitions due to uncertainties surrounding economic activity and tariffs. As a result, debt levels will remain constant or even decrease, which in turn will support spreads.

Chart: Lower issuance volume expected for high-quality EUR-IG corporate bonds

_{Source: J.P. Morgan, in billion euros}

Healthcare and financials favoured
Overall, we expect the positive trend in European IG corporate bonds to continue, making the asset class attractive for investors due to its running yields and diversification effects.

At the sector level, the picture is relatively uniform. The automotive sector has overcome its recent weakness and no longer offers an exceptional yield premium. We consider cyclical sectors, such as chemicals and energy, to be less appealing – unlike financials, which are unlikely to be affected by potential tariffs. Investors should also consider the lower end of the capital structure. The healthcare sector, particularly major pharmaceutical companies, and the telecom sector are likewise favourable, in our view. For investors, a diversified corporate bond portfolio can therefore be a profitable form of boredom – in the best sense of the word.