In spite of the depressing economic outlook, there is reason to be optimistic about the riskiest of debt instruments - high-yield.

Philip Milburn, manager of Aegon's £78m High Yield Bond fund, says the sector has been punished unfairly by fire sales from hedge funds and structured products that have been forced to unwind due to the misbehaving leveraged loan market, high-yield's "bigger sister" and biggest problem.

While it is realistic to imagine a recovery in debt instruments will start with investment-grade first, Mr Milburn says high-yield is actually better positioned in terms of liquidity.

"In the cold light of day, there has been a little better liquidity in high-yield than investment-grade, relative to the usual situation. We are used to illiquidity and, at the moment, you could trade all of the bonds in the fund," he says.

Seduced by high-yield spreads reaching 2,000 basis points last October, Mr Milburn poured his cash reserve, which was 15 per cent at its height in June, back into the asset class.

This proved premature, he acknowledges, as well as costly to performance. The market appears to have bottomed out in November and early December.

According to Morningstar, the fund reported a loss of 29.8 per cent in the year to January 5, and 26 per cent over the three months to that date. The average fund in the sector lost 26.7 per cent and 21.6 per cent, over those periods.

"We have been quick to mark down our prices to the market values. We were fully invested too early and had a couple of bad stocks," he says.

Those stocks included the US equivalent of Yellow Pages, RH Donnelley, and nationalised mortgage lender Bradford & Bingley.

"I thought I was being clever buying Bradford & Bingley when it was trading at 50p in the pound, but it is now trading in the teens. However, that will be one of our better-performing bonds this year; the catalyst will come when the market realises it is still paying coupons on its bonds and, in a run-off scenario, there probably still will be residual value."

Mr Milburn says he thought RH Donnelley, which generates up to £500m cash per year, could cope with its leveraged business model. But instead the company is "being forced down the avenue of undertaking debt for equity". The stock has fallen 30 cents in the dollar since purchase. Although Mr Milburn has "mentally written it off" - holding only 0.5 per cent in that position - it is still paying coupons, he says.

Controversially, Mr Milburn expects defaults to be lower in this cycle than in the TMT cycle. "You have small companies generating cash rather than TMT companies with no business model, haemorrhaging through debt" he says. However the recovery rates for businesses in this cycle will be "incredibly low", he adds.

"When we do get defaults, the recovery of the overall entity might be similar to other cycles but the recovery at subordinate bond level will be dreadful," he says.

Mr Milburn voluntarily limits CCC exposure, where the greatest defaults are anticipated, to 20 per cent, but presently has an allocation of just 5.9 per cent.

Anna Lawlor is deputy features editor at Investment Adviser