Corporate Hybrids: How to navigate complexity
Daniele Paglia observes that the corporate hybrid market has emerged as a major beneficiary of the increase in public debt and investors' shift into corporate bonds. However, while the outlook currently seems promising, a well-thought-out investment strategy is essential.
Author: Daniele Paglia
Three key takeaways on the opportunities of corporate hybrids:
- Several factors are currently creating a favorable environment for hybrid corporate bonds.
- Rising government debt, particularly in the US and Europe, acts as a driver – but also introduces complexity. A well-thought-out strategy is therefore essential.
- Specific opportunities can currently be found in certain sectors and issuers that stand out.
The outlook for the corporate high yield and corporate hybrids market appears promising, supported by several positive factors. The economy is growing at a moderate pace, short-term interest rates are trending downward, fiscal stimulus remains uninterrupted and is expected to increase further in Europe, and both corporate and consumer balance sheets are solid. Investors are not displaying signs of euphoria, and their positioning is not extreme, which is encouraging. Liquidity is abundant, with record levels parked in money market instruments.
Delicate balance between opportunities and risks
However, while these factors create a favorable environment, there are also arguments suggesting that a correction may be overdue. The trade war and erratic policies from the White House have had little impact on investment, consumption, and inflation so far. But these effects could still materialize with a delay, potentially creating headwinds for the market.
Adding to the complexity is the ballooning U.S. public debt, which has been exacerbated by the extra-deficit prospects from President Donald Trump’s “Big Beautiful Bill.” The recent government shutdown has only added further complications, creating uncertainty that could ripple across the global bond market. High expected government issuance and inflation concerns are already weighing on long-term rates. Against this backdrop, the trend towards steeper yield curves is likely to continue, while flatter spread curves make longer credit duration less attractive. These dynamics highlight the delicate balance between opportunities and risks in the current market environment.
Rising public debt and the shift toward corporate bonds
Soaring budget deficits are a concern not only overseas but also in Europe, where long-dated government bonds have recently suffered negative performance. Concerns over future issuance have pushed 30-year yields in Germany to their highest levels since the euro crisis in 2011, while political instability and a credit rating downgrade have driven French 30-year yields even higher. In response, investors are shifting allocations towards investment-grade corporate bonds, which has pushed credit premiums lower.
Amid this shift, the corporate hybrid market (see chart below) has from my perspective emerged as a major beneficiary, attracting funds from yield-hungry investors. While the yield difference between senior and subordinated bonds is at historical lows, it still more than compensates for the risks, making subordinated bonds of high-quality investment-grade issuers particularly appealing. These bonds, while often more volatile than senior bonds, offer an attractive risk-return trade-off for investors willing to withstand the fluctuations. So how should one proceed for an investment standpoint?
Historical Performance (in %, hedged in EUR)
Possible strategic approaches
In my opinion, a well-thought-out strategy is essential for navigating the sector effectively. A thorough bottom-up fundamental analysis of each individual issuer should form the foundation of the investment process. Detailed credit analysis is especially critical for subordinated bonds, as their lower repayment priority results in a lower recovery value compared to senior bonds. The hybrid market’s higher liquidity relative to the general bond market allows for active and dynamic management of issuer exposure in portfolios.
To complement this, a top-down allocation strategy along dimensions such as sector, rating, and country of risk can help the alignment with broader investment goals while avoiding unwanted risk concentrations. Dynamic control of beta risk is in my view also crucial for generating alpha, alongside positioning along the first-call curve (which indicates the earliest date on which issuers can redeem a bond early) and cross-currency relative value analyses to evaluate investments in different currency markets. This multi-dimensional approach can help investors capitalize on opportunities while managing risks effectively.
Which sectors to choose?
In terms of specific opportunities, certain sectors and issuers currently stand out. The telecom sector, for instance, offers in my view value due to a favorable regulatory environment and a more rational pricing framework in key markets. Additionally, diminishing investment needs in fiberglass and 5G networks are leading to higher free cash flows for telecom companies. While European telecoms appear expensive, Canadian telecoms in USD still offer attractive spreads, presenting compelling opportunities. Similarly, the energy sector seems appealing, serving as a hedge against geopolitical tensions and offering value that is not yet priced for perfection. Within this sector, selected Canadian and US issuers are likely to provide attractive opportunities, further diversifying the range of investment options.
Recent issuance trends
The positive momentum in the corporate hybrid market is reflected in recent issuance trends (see chart below). In the first three quarters of 2025, the European market recorded EUR 27 billion of gross issuance across 42 bonds, with increasing diversification as some companies issued their first hybrid bonds.
Market for Corporate Hybrids (ICE Indeces, notional amount in EUR bn)
Growth expected on both sides of the Atlantic
Looking ahead, I expect the corporate hybrid market to continue its dynamic growth on both sides of the Atlantic. Its ability to address the needs of both issuers and investors underpins its expansion. For investment-grade issuers in sectors with high recurring investment needs, such as telecoms or utilities, corporate hybrids provide a way to maintain a solid credit profile without resorting to expensive equity issuance. For investors, corporate hybrids can offer an attractive yield pick-up, drawing a more diversified investor base. These trends are likely to persist, solidifying the corporate hybrid market as a core component of institutional investors’ fixed income asset allocations.
As the market evolves, its role in bridging the needs of issuers and investors is likely to grow, ensuring its continued relevance in the broader financial landscape.
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