PA ANALYSIS: Will EU high yield boom survive ECB tapering?

Added 13th September 2017

European high yield has had a good run so far this year but can that continue as the European Central Bank turns off the quantitative easing (QE) tap?

PA ANALYSIS: Will EU high yield boom survive ECB tapering?

There’s no getting around the fact that it has been a tough year for fixed income managers and investors, especially when viewed alongside some of the high returns achieved by their active equity manager counterparts.

Generally speaking, active managers were on a roll during the second quarter driven by 63% of equity managers outdoing their benchmark, according to new data from Lyxor Asset Management.  

Fixed income managers, on the other hand, were severely hampered by the low interest rate environment, with only 35% beating their benchmark in Q2, “a marked reversal from the 53% seen in the first three months of the year”, said Lyxor.

One exception is in the area of high yield, particularly in the gradually recovering eurozone, which has proved a fertile ground for equities and junk bonds alike.

But as the ECB steadies its hand to trigger the tapering process, bringing an end to the extraordinary amount of monetary stimulus, investors are understandably worried that HY will no longer enjoy the upper hand.   

However, Peter Aspbury, JP Morgan European high yield manager, argues that the asset class could be the "overlooked fixed income haven for a raising rate environment".

“Although EU HY is not going to be immune to a move out in underlying government yields, investors can still get a lot of yield for very little duration compared to most other fixed income asset classes,” he said.

“So, while rate normalisation will put negative pressure on government bond and lower spread, longer duration credit portfolios, EHY can offer investors a potential hideout by virtue of its relatively lower sensitivity to rising rates.”

Importantly, the EHY fundamentals continue to look attractive in what is still a very low yielding environment.

“Realistically the scope for further gains looks limited, but by no means is the market over-inflated or in bubble territory.

“Today, 70% of the EHY market is double B rated (rather than single B or triple C rated) offering a much higher average credit quality than any point in the history of the asset class and a much high average credit quality than US high yield (USHY).”

That said, Aspbury’s own fund isn’t exactly leading the pack, returning 9.55% over the last 12-months against his peers in the Fixed Interest Europe category, according to data from FE. Though he is by no means the worst performer within his sector, the fund’s returns don’t quite stack up to Robeco’s European HY Bond’s 15.54% nor Barings European HY Bond’s 15.32%.   

Meanwhile, Axa senior credit strategist Greg Venizelos believes that HY “looks set to come under pressure for the remainder of the year unless we see a meaningful back-up in government bond rates”.

The HY/IG decompression theme was noticeably on display last month (see figure) during the risk-off environment triggered by escalating tensions between North Korea and the US.

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Source: Bloomberg, BAML and AXA IM Research

 

 

 

 

 

 

 

 

 

“While we have advocated the reflation trade for the best part of this year, we recognise that it looks set to come under pressure for the remainder of 2017, unless we see a meaningful backup in rates,” said Venizelos.  

“This is particularly the case for the USD credit market where HY holds a narrow total return advantage of 70bp over IG year-to-date.”

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Kristen McGachey

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Kristen joined Last Word Media and the world of financial journalism in April 2016, leaving behind a career in a legal publishing firm as a senior researcher turned assistant editor.

This native Angelino initially moved to the UK in 2008 to complete her undergraduate studies at the University of Nottingham. She subsequently obtained a Masters degree in Philosophy with Literature from the University of Warwick.

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