Europe's High-Yield Investment Opportunities
"Risk on" and "risk off" continue to be debated and the weakness of the global economy is weighing on investors, but European high yield corporate bonds are enjoying something of a rally.
"Issuance had been strong because the market is relatively young compared to its US counterpart although this is on track for the second record year in a row," said Richard Phelan, head of the European credit research at Deutsche Bank.
"It's still one fifth or a quarter to its comparable US market. Our message for investors is that we are constructive and new issuance has been very strong with a lot of volatility in the markets. We think that investors should target returns in the 8-9 percent category," he said.
High yield bonds – non investment grade, speculative or junk bonds – are rated below investment grade so carry a higher risk of default, but for the extra risk they typically pay a higher yield.
Phelan said default rates within the European high yield market were very low compared to the levels seen at the height of the global recession.
"Default rates are relatively benign, in the 2 percent context in contrast to the double digit percentages seen as recently as a year and a half ago. The information that we look at in terms of the universe of companies in European high yield still seems strong, encouraging in terms of improved balance sheets and leveraging," Phelan said, adding the Deutsche Bank expectes default rates to stay low for the next 12-18 months.
With the euro zone region still grappling with the sovereign debt crisis enveloping the periphery, European companies are in a treacherous economic environment and inflation and rising interest rates remain an issue for this asset class.
"Sentiment is fragile and that's been reflected in some of the recent performance. June has been a down month for the asset class. Perhaps with doubts about the equity markets and commodities and some of the anemic returns, it's been a secular movement out of these other asset classes into high yields, which we would expect to continue," Phelan added.
There has been around $48.4 billion issuance of below investment grade European high yield corporate bonds in 2011 year to date, according to data analysts Dealogic. This compares with $28 billion for the same period last year.
"Allocation into the corporate bond market will continue. The new issuance pipeline looks good and investors should note the market is much different to what it was 10 years ago, when the market was heavily dominated by telecoms and cable companies, we now have much more diversity," Phelan said.