European High Yield Update - December 2015

LIQUIDITY CONCERNS DOMINATE AT YEAR-END

Stephen Marsh
Fixed Income Portfolio Specialist

Can you provide an overview of the high yield market for December and for 2015 as a whole?

The year’s been an interesting one and December’s been a good example of that, whereby the benchmark underperformed by almost 2.3%, whereas our portfolio outperformed the benchmark by more than 1.5%. We’ve seen that theme play out in September also as well. We’ve also seen throughout the year that it’s been very favourable for outperformance for our clients.

The key drivers to that outperformance has been twofold. Firstly, selection. And it’s about what you don’t hold as much as what you do hold. For example, we haven’t held Abengoa, Isolux or Novo Banco when they have sold off aggressively, which has been over the last few months.

Also, secondly, we’ve been defensively positioned at the right points over the year. We’ve been overweight the packaging, cable and wireless sectors and underweight the distressed sectors such as energy, metals and mining.

Liquidity concerns intensified towards the end of the year. What are your views on that?

Liquidity has been an interesting topic and one which has been in the news over the last few months. I think it’s one of bifurcation whereby you’ve got the distressed, lower quality names which have been somewhat illiquid, and on the other hand you’ve got the rest of the market behaving normally, given the seasonality.

You can break it down into three key points. I think the first point is the headlines have been focused on US distressed high yield funds. That hasn’t flowed over to Europe yet and you’ve still seen that divergence within there. The second point is that you’ve seen outflows in the ETF market. Now, ETFs focus more of their investments on the higher quality, BB crossover space. We’ve actually seen inflows in our fund so we’ve put that money to work where we’ve seen better valuations, ie the single B area of the market. Now, the third and final point is the issuance over the last six months of 2015 has been relatively low in the European markets and we think that the issuance is going to pick up in 2016 and that will bring liquidity back to the market.

What is your outlook for 2016?

Our outlook for 2016 can be broken down into three key themes. I think the first key theme to focus on is one of continued divergence. Specifically, the European versus the US divergence has been driven by two factors.

Firstly, the energy space, whereby the US index has a much higher weight to energy, is more distressed in that segment. The European market has been somewhat sheltered from that so far. Also, we’ve seen a divergence of monetary policy, QE versus the first Fed hike. We think that will continue to play out in the market.

Now, the second key theme to think about is avoiding defaults. Now that sounds obvious but selection is so important we think this year. It’s about having a strong team, a large team which can get out there and meet the management, question and quiz the management, and also pull apart the balance sheets. And that helps us avoid the likes of Isolux and Abengoa.

Now the third key theme that we think will drive 2016 is one of continued volatility. That will create some challenges in the market place but that will also create some opportunities for generating outperformance for our clients, and we think 2016 will be a positive year for European high yield markets.

2016-GL-3188