Why the expert sees opportunities in European high yielders
European monetary policy and the basically sound health of the corporate sector make European high-yield bonds attractive, says Danske Invest's chief analyst.
After a rough ride for European high-yield corporate bonds at the start of the year, they are starting to look attractive for a number of reasons.
First, companies in Europe are broadly in better shape now than their US counterparts.
“Corporate Europe has for some years now swapped risk appetite for a conservative approach to doing business and companies have focused on reducing debt and postponing investments over the past few years. This means, for example, that European companies have improved their capacity to cover the interest rate costs of any debt they may have, while the opposite is true of US companies,” explains Bo Bejstrup Christensen, chief analyst for Danske Invest, which focuses on European high-yield corporate bonds through its fund Danske Invest Euro High Yield Bonds.
No wage pressures
Second, the cautious approach pursued by European companies in recent years has resulted in low job creation and hence high unemployment, though unemployment is now falling.
“High levels of unemployment mean European companies are not experiencing much pressure on earnings margins from wage costs,” says Bo Bejstrup Christensen.
In contrast, the US is currently at a stage in the economic cycle where wage pressures are starting to mount, though there is no overheating as yet. Wage pressures in Europe are still very subdued, so companies here will very probably be able to continue increasing their margins for some time, says Bo Bejstrup Christensen
Good financing conditions
Third, he sees overall financing conditions as more favourable for European companies than is the case in the US – for a number of reasons.
“The US central bank is slowly tightening monetary policy, while the situation in the eurozone is the opposite,” says Bo Bejstrup Christensen.
The European Central Bank, the ECB, has just eased monetary policy again, and bank chief Mario Draghi clearly and unequivocally stated at the time that further easing would follow if needed.
“Our view is that Europe’s very accommodative monetary policy will increase demand for European high yield bonds,” explains Bo Bejstrup Christensen.
Banks and their willingness to lend to companies highlights another disparity. Corporate access to credit has been easing for many years in the US, but this trend is starting to turn, with banks again beginning to tighten credit standards slightly.
“The opposite is true in the eurozone. European bank lending to companies only began to loosen a year ago. European banks are still easing their credit standards and with help from the ECB we expect this trend will continue,” says Bo Bejstrup Christensen, who adds:
“We estimate European bond issuance will increase, as the environment in Europe supports companies financing themselves via the capital markets.”
Politics and growth are risks
High-yield corporate bonds are bonds issued by companies with a credit risk at the high end of the scale. Companies with a high-yield status are assessed to have a greater risk of not being able to meet their payment obligations than companies with investment-grade status.
As investors assume a greater risk by investing in high yield bonds rather than investment-grade bonds, the return is also higher. Companies generally issue bonds as an alternative to, for example, taking out a bank loan to finance a capital requirement, such as a new investment.
There are several risks associated with investing in European high-yield bonds. The first is political, explains Bo Bejstrup Christensen.
“While Europe’s economy has performed well, there are still a lot of political risks in Europe – such as the UK referendum, the so-called Brexit vote, on EU membership in June, and a dysfunctional Spanish government that will likely end with a new election,” says Bo Bejstrup Christensen.
The refugee crisis is another risk, estimates Bo Bejstrup Christensen, as it could flare up again at any time.
“A further risk is global growth expectations disappointing, especially in China and the emerging markets, though also in the US. Disappointment would hit eurozone growth too and damage the ability and willingness of companies to borrow money, expand and create growth,” explains Bo Bejstrup Christensen.