European High Yield Update - February 2016

How has the strategy performed amid the recent volatility?

So, the strategy has performed very well in February and year-to-date, we’re up a little over 40 basis points relative to the benchmark. It’s mainly been driven by underweight to the banking sector which has had a lot of volatility and stress around it. Also underweight the energy sector and overweight cable and wireless. But really what’s been playing out within these sectors is the bottom-up security selection.

How much new issuance has there been?

Issuance has been very low. You know we’ve actually seen a couple of deals come to market and they’ve been pulled, and that’s through a lack of demand for those deals and also the pricing hasn’t been attractive for the businesses to actually issue the debt. We actually spoke to one of our traders recently, Paul Cable, about Lease Plan, a deal which was coming to market. And we wanted to participate but Paul mentioned that the bank would love us for a long time if we did participate. Clearly, that has no influence on us, but its gives a good colour of the market, showing us that there is a lack of demand out there. This deal was actually pulled from the market because Lease Plan didn’t want to come to market at such high yields, it just wasn’t attractive on a weighted average cost of capital perspective.

Now that’s what we’ve seen recently but going forward, we think the secondary market is going to become a bit more normal, a bit more liquid again and thus the primary market will open up and maybe start to flourish somewhat in March and April.

What impact has the arrival of ‘fallen angels’ had on the high yield market?

There’s a lot of investment grade debt on the investment highway to high yield. In fact, within the European market we’re seeing €28 billion in BBB, mid to low rated on negative outlook or negative watch by ratings agencies. Of that €28 billion, we think a little more than €20 billion will be downgraded from investment grade to high yield.

So there’s definitely a significant impact on the markets but the real question is, is it falling angels or is it falling knives? And I think that’s where our collaboration between investment grade and high yield analysts is paramount. But not only that, it’s very important to do that bottom-up fundamental credit research.

What’s your outlook for the rest of 2016?

So whilst our outlook is more volatility for the rest of the year, we think that there’s a little window at the moment where we’re seeing the high yield market rally aggressively. We’re seeing a lot of money coming into the high yield market, a lot of inflows and that in turn is going to improve liquidity in the secondary market and that will help the primary market. And thus we’re going to see more issue in our opinion, a lot of new deals coming to market and our bottom-up fundamental credit research process is going to be able to isolate and find those attractive deals and we can allocate capital accordingly.

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