European High Yield: a tale of low defaults and diversification | Financial Adviser - Aberdeen Asset Management
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March 16, 2017

European High Yield: a tale of low defaults and diversification

Following a strong start to 2017, valuations in European high-yield (EHY) look less attractive than they did at the end of 2016. However, while some volatility in the short term is to be expected, the asset class has proven its worth in testing economic times.

Recent years have seen strong growth trends in the European corporate debt markets. This has provided a solid base for EHY to grow, becoming increasingly diversified with improved overall credit quality. Rather unsurprisingly, it is more appealing to investors as a result. With two full credit cycles since the late 1990’s behind it, the EHY sector is now an integral part of the global leveraged finance market. It may still be perceived as the smaller sibling of US High Yield, but that masks how fast it is growing and maturing.

This maturity can be seen in both size – the market has grown from €41 billion in January 2002 to €286 billion in January this year – and the decreased volatility relative to US High Yield that has occurred since 2012 (according to Bloomberg data), albeit a reasonable proportion of the latter trend has been down to stresses in the US energy market.

Relative to historic levels, yields are low. Yet with income and yield increasingly hard to come by a distribution of over 4% is not to be sniffed at. And with yields on government bonds often negative, as is the case of 5-year German debt, the overall spread of yield over government bonds is even higher.

New world of negative 5yr Bund yields

EHY chart 1

Five year generic German and US government yields.
Source: Bloomberg. For illustrative purposes only. No assumptions regarding future performance should be made. 8 June 17.
Past performance is not a guide to future results.

Although always important, with yields at relatively low levels, the role of defaults becomes heightened. The overall outlook is encouraging. Moody’s predict that rates will be 2% in Europe, compared to 4% in the US. Even so, rigorous security selection is required to weed out the companies most likely to default.

High yield’s equity-like qualities are well known. Its correlation with government bonds is low. To reinforce this point, we singled out instances where US 10-year Treasury yields rose by 1% and compared high yield returns over this period. The results are below, and are illuminating.

High yield: a haven in times of US Treasury stress?graph 2.fw

US High Yield = H0A0 Index
Euro High Yield = HEC0 Index
European Corps = The BofA Merrill Lynch Euro Corporate Index
Source: Aberdeen Asset Management, February 2017
Past performance is not a guide to future results.

As you can see, high yield offers particular good diversification during these periods. Having an allocation makes sense as part of a broadly diversified portfolio.

In times of uncertainty, investors traditionally flock to the ‘safe haven’ assets, such as government and investment grade bonds. In normal economic conditions, these would offer a relatively safe spot to park your cash. But these aren’t conventional times; central banks have exhausted their weaponry, and as of 28 February 2017 45% of developed market bonds now yield less than 1%, and 20% of those offer negative yields, according to JP Morgan data. Brexit, key elections in Europe and Donald Trump don’t help matters either.

It could be a bumpy road ahead for European high-yield bonds, as it could be for markets globally, but the combination of yield and relatively low duration in return for its credit risk remains compelling. EHY certainly warrants the increased interest among income-seeking investors.

Ben Pakenham
Deputy Global Head of High Yield

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The above marketing document is strictly for information purposes only and should not be considered as an offer, investment recommendation, or solicitation, to deal in any of the investments or funds mentioned herein and does not constitute investment research as defined under EU Directive 2003/125/EC. Aberdeen Asset Managers Limited (“Aberdeen”) does not warrant the accuracy, adequacy or completeness of the information and materials contained in this document and expressly disclaims liability for errors or omissions in such information and materials.

Any research or analysis used in the preparation of this document has been procured by Aberdeen for its own use and may have been acted on for its own purpose. The results thus obtained are made available only coincidentally and the information is not guaranteed as to its accuracy. Some of the information in this document may contain projections or other forward looking statements regarding future events or future financial performance of countries, markets or companies. These statements are only predictions and actual events or results may differ materially. The reader must make their own assessment of the relevance, accuracy and adequacy of the information contained in this document and make such independent investigations, as they may consider necessary or appropriate for the purpose of such assessment. Any opinion or estimate contained in this document is made on a general basis and is not to be relied on by the reader as advice. Neither Aberdeen nor any of its employees, associated group companies or agents have given any consideration to nor have they or any of them made any investigation of the investment objectives, financial situation or particular need of the reader, any specific person or group of persons. Accordingly, no warranty whatsoever is given and no liability whatsoever is accepted for any loss arising whether directly or indirectly as a result of the reader, any person or group of persons acting on any information, opinion or estimate contained in this document. Aberdeen reserves the right to make changes and corrections to any information in this document at any time, without notice.

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Risk warning:

Risk warning

The value of investments and the income from them can go down as well as up and your clients may get back less than the amount invested.

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