European High Yield - December

Why security selection matters in high yield

Security selection is what matters most in the long-term. Irrespective of fundamentals and technicals, that’s the biggest determinant of returns for our investors. In other words, the European Central Bank’s short-term impact on market sentiment doesn’t drive why we invest in a company. We look from the bottom-up to identify long-term positive stories, where the income profile is attractive and the potential for capital gains most rewarding for our clients.

Recent events in European high yield serve as a stark reminder why security selection is so important. After a capital raising plan fell through, Abengoa filed for preliminary credit protection in Spain on November 25. The Spanish solar energy company is a large issuer in European High Yield with several of its bonds listed in the benchmark¹. In recent months these bonds have lost between 80%-90% of their value as the company struggled to raise new capital amid heavy debts. It’s uncertain what will happen now, but to avoid bankruptcy Abengoa must reach an agreement with creditors before the end of March. The failure to do so could result not only in Spain’s largest bankruptcy, but possibly one of the biggest this asset class has ever experienced.

Fundamental research is at the heart of our approach and this analysis helps us not only uncover the best opportunities but also the companies to be avoided. Looking at a company’s cash flow and management structure is a good starting point, but our assessment does not end there. The issuer’s maturity and liquidity profile are also evaluated, alongside its full capital structure. In conjunction with this, we also meet with company management teams to carry out further due diligence. To get a full picture of a company and the potential risks/rewards involved from investing, all these areas are analysed.

Our bottom-up research 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.

The specific securities identified and described above do not necessarily represent securities purchased or sold by T. Rowe Price. This information is not intended to be a recommendation to take any particular investment action and is subject to change. No assumptions should be made that the securities identified and discussed above were or will be profitable.

¹ Bank of America Merrill Lynch

2015-GL-3132