European High Yield - May 2016

Don’t Sacrifice Fundamentals in the Hunt for Yield

The European Central Bank (ECB) will kick-off its corporate bond-buying programme in June. Even before the purchases have commenced, the ripple effects are being felt in European high yield as more investors move further down the credit curve. But are they focusing on credit risk in their hunt for yield?

Let’s look at performance first. In April, the benchmark¹ returned 1.95%, with all sectors registering a positive performance. Across the rating spectrum the performance was consistent, but dig a little deeper and there were some interesting trends. Notably, at the upper end of the rating spectrum issuers with larger, higher beta structures tended to outperform. Similarly, at the lower end there was a slight improvement in the price of some more distressed names. This is being driven by investor demand for generic rather than issuer specific risk – an approach that in my view carries risks and is particularly vulnerable in a risk-off environment.

In essence, the hunt for yield has been overshadowing the fundamentals and importance of security selection. I believe longer-term security selection matters the most and will ultimately be the biggest determinant of returns for investors. While the ECB provides a strong technical support, it does not drive our investment decisions. We seek to identify long-term positive stories from the bottom-up, where the income profile is attractive and the potential for capital gains most rewarding for our clients.

This approach continues to drive our overweight in the single-B rated segment of the market, where we have a preference for bonds with high coupons and shorter-dated maturities as price volatility is more contained in such securities.

¹ BofA ML European Currency HY Constrained Ex Subordinated Financials Index Hedged to EUR

2016-GL-3996