LONDON: High yield investors once viewed Europe as a distraction from the developed US market, but are now scrambling to increase their exposure to the region in light of recent outperformance coupled with a less generous approach to equity investors.
European and US high yield experienced a "rare decoupling" in the last two weeks of July, with euro high-yield returning 0.84%, compared with a 0.43% loss in the dollar market, according to JP Morgan analysts.
That has had a knock-on effect to fund flows with US high yield bond mutual funds recording a USD1bn outflow last week, compared to EUR173m of inflows in Europe.
Not only are yields on offer in Europe now several degrees higher than in the US, but the former offers better credit protection and insulation from rate hikes.
"The European high yield market definitely looks more attractive compared to the US, particularly given that credit quality is on average better in Europe," said Jorgen Kjaersgaard, a high yield portfolio manager at AllianceBernstein.
"With bund yields at 1.6% and, in contrast to the US, no cliff risk of a rates move, there is a very strong support in the market."
Given greater relative value opportunities, investors have been rushing to set up funds that can invest globally and give them greater flexibility to dabble in different markets.
That has made the switch into Europe easier. Global high yield funds have doubled total net assets over the past two years to USD170bn, according to data from EPFR.
Barclays notes that this now dwarfs the dedicated European high yield fund universe, with roughly seven times the asset base.
CONSERVATIVE POSITIONING
By the end of July the European high yield market had returned a full percent more than the US during 2013 at 4.46% versus 3.41%, according to BofA Merrill Lynch analysts, who add that "no other segment is anywhere close to those levels."
Crucially, chasing this performance has not meant that investors have had to sacrifice protections as new issues in Europe have better average credit quality than in the US.
Europe has seen a higher ratio of BB rated issuance this year, according to Credit Suisse, while 10.3% of US new issues up to July 16 were rated Triple C compared to just 2.4% in Europe.
The average spreads on offer at every point of the credit spectrum are also higher in Europe than the US, according to JP Morgan, with Triple C names offering an average spread of 922bp compared to just 776bp in the US.
"We're increasingly becoming more negative on the US side," said Fraser Lundie, co-head of credit at Hermes Fund Managers.
"The sell-off of May and June has been very quickly forgotten, and we've retraced a lot now back to what I think are very expensive levels, particularly from a convexity perspective."
Lundie notes that negative convexity, a problem across the market, is more acute in the US. A good measure of just how much upside US investors have surrendered is the percentage of bonds trading above their next call price.
On index weighting, 35% of bonds in the BofA Merrill Lynch's US High Yield Index are trading above their next call, while less than a quarter of bonds in its European index are. As result, Lundie states that for US high yield, Hermes is now "getting back to the conservative positioning we had at the start of May."
BAD FOR EQUITY, GOOD FOR CREDIT
So far the European market's strength has not encouraged businesses to excessively raise leverage. Morgan Stanley notes that net leverage fell by 0.3x in the first quarter of 2013, despite the record pace of issuance in European high yield.
That is predominantly because companies refinancing loans rather than adding debt to their balance sheet have driven supply. In the US, however, where economic growth is now more firmly entrenched, equity friendly measures such as dividends and share buybacks are becoming more frequent, often to the detriment of credit investors.
European companies ploughing money into balance sheet repair are often hated by the equity markets, but provide excellent returns for credit investors.
ArcelorMittal stock, for example, fell by nearly 5% on the day it announced plans to issue shares and convertible notes to pay down billion of dollars of debt in January, while its bonds rose 3 points.
"Certain sectors in the US are becoming very equity friendly so we're looking to be light on these, whereas the fact Europe is still in balance sheet repair mode is good for high yield credit investors," said Lundie.
indiatimes.com
European and US high yield experienced a "rare decoupling" in the last two weeks of July, with euro high-yield returning 0.84%, compared with a 0.43% loss in the dollar market, according to JP Morgan analysts.
That has had a knock-on effect to fund flows with US high yield bond mutual funds recording a USD1bn outflow last week, compared to EUR173m of inflows in Europe.
Not only are yields on offer in Europe now several degrees higher than in the US, but the former offers better credit protection and insulation from rate hikes.
"The European high yield market definitely looks more attractive compared to the US, particularly given that credit quality is on average better in Europe," said Jorgen Kjaersgaard, a high yield portfolio manager at AllianceBernstein.
"With bund yields at 1.6% and, in contrast to the US, no cliff risk of a rates move, there is a very strong support in the market."
Given greater relative value opportunities, investors have been rushing to set up funds that can invest globally and give them greater flexibility to dabble in different markets.
That has made the switch into Europe easier. Global high yield funds have doubled total net assets over the past two years to USD170bn, according to data from EPFR.
Barclays notes that this now dwarfs the dedicated European high yield fund universe, with roughly seven times the asset base.
CONSERVATIVE POSITIONING
By the end of July the European high yield market had returned a full percent more than the US during 2013 at 4.46% versus 3.41%, according to BofA Merrill Lynch analysts, who add that "no other segment is anywhere close to those levels."
Crucially, chasing this performance has not meant that investors have had to sacrifice protections as new issues in Europe have better average credit quality than in the US.
Europe has seen a higher ratio of BB rated issuance this year, according to Credit Suisse, while 10.3% of US new issues up to July 16 were rated Triple C compared to just 2.4% in Europe.
The average spreads on offer at every point of the credit spectrum are also higher in Europe than the US, according to JP Morgan, with Triple C names offering an average spread of 922bp compared to just 776bp in the US.
"We're increasingly becoming more negative on the US side," said Fraser Lundie, co-head of credit at Hermes Fund Managers.
"The sell-off of May and June has been very quickly forgotten, and we've retraced a lot now back to what I think are very expensive levels, particularly from a convexity perspective."
Lundie notes that negative convexity, a problem across the market, is more acute in the US. A good measure of just how much upside US investors have surrendered is the percentage of bonds trading above their next call price.
On index weighting, 35% of bonds in the BofA Merrill Lynch's US High Yield Index are trading above their next call, while less than a quarter of bonds in its European index are. As result, Lundie states that for US high yield, Hermes is now "getting back to the conservative positioning we had at the start of May."
BAD FOR EQUITY, GOOD FOR CREDIT
So far the European market's strength has not encouraged businesses to excessively raise leverage. Morgan Stanley notes that net leverage fell by 0.3x in the first quarter of 2013, despite the record pace of issuance in European high yield.
That is predominantly because companies refinancing loans rather than adding debt to their balance sheet have driven supply. In the US, however, where economic growth is now more firmly entrenched, equity friendly measures such as dividends and share buybacks are becoming more frequent, often to the detriment of credit investors.
European companies ploughing money into balance sheet repair are often hated by the equity markets, but provide excellent returns for credit investors.
ArcelorMittal stock, for example, fell by nearly 5% on the day it announced plans to issue shares and convertible notes to pay down billion of dollars of debt in January, while its bonds rose 3 points.
"Certain sectors in the US are becoming very equity friendly so we're looking to be light on these, whereas the fact Europe is still in balance sheet repair mode is good for high yield credit investors," said Lundie.
indiatimes.com
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