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Is Europe the place to be for fixed income?

The eurozone debt crisis has seen European debt markets suffer in recent years.


The eurozone debt crisis has seen European debt markets suffer in recent years. But can falling yields in peripheral government debt, “credit friendly” corporates and a growing high yield market see the region outperform?

Sovereign bond yields in Europe’s peripheral economies have come back down from highs of over 7 per cent witnessed during multiple euro crisis flare-ups throughout 2011/12.

According to recent Bloomberg data from the end of September, yields on both Italian and Spanish government bonds now stand at around 4 per cent, while Greek sovereigns have the highest yield of approximately 9.6 per cent.

Comparing Barclays aggregate credit market indices, European credit has returned 4.49 per cent year to date, outperforming US returns of -0.69 per cent and -2.19 per cent for UK corporates.

The improving picture for European debt has seen some bond managers look for value and new opportunities across Europe’s sovereigns, high yield and investment grade.

Barclays Wealth chief investment officer Kevin Gardiner recently stated that the European government bonds look set to push ahead of other fixed interest markets.

He says: “The main European government indices are likely to continue to outperform global treasuries simply because they include Italy and other pro-cyclical peripheral markets, and because growth and inflation will remain much more muted than in the US.”

Rathbone Unit Trust Management bond manager Bryn Jones agrees that peripheral sovereigns have the potential to outperform as yields look likely to fall back down closer to bunds, gilts and treasuries.

Jones says he is “not playing European sovereigns directly” other than a small amount of exposure to Irish sovereign debt, on the belief that the country will continue to see upgrades.

The co-manager of the multi-manager £51.2m Rathbone Strategic Bond fund has also been buying funds with exposure to European sovereigns as a way of indirectly accessing the space.

The £136.1m Hermes Global High Yield Bond fund manager Fraser Lundie highlights opportunities in European corporate debt thanks to the region’s “credit friendly” companies. He says: “At the moment we have a moderate overweight to Europe.

“This is partly on valuation grounds and also because this stage of the economic cycle is throwing up investment opportunities in companies that are focused on credit friendly things such as balance sheet repair, rather than being shareholder-focused.”

Mario Draghi’s statement that the ECB will ‘do whatever it takes’ to support the Eurozone has also prompted Jones to add peripheral corporate and bank bonds to the Rathbone Strategic bond and £127.6m Rathbone Ethical Bond funds.

He adds: “We have bought some peripheral bank paper in sterling denominated and some peripheral corporates.

“They have been pretty beaten up since the sovereigns became beaten up too, although the majority of their revenue comes from out with the county in which they are stated.”

European high yield also looks attractive to managers and advisers when compared to the once dominant US high yield market.

During the month of August 2013, European high yield outperformed its US equivalent by approximately 90 basis points, according to Jones.

Hermes credit team co-head Mitch Reznick also points out that the high yield space in Europe has grown substantially faster than the once dominant US high yield market.

Lundie adds that the European market currently presents the best opportunity within global high yield.

He says: “In the US arguably it isn’t the time to be in high yield and not in certain parts of emerging markets but actually in Europe now probably is a good stage to be in high yield.”

Skerritts head of investment Andrew Merricks sees opportunities in the returns from European high yield market, but stresses the importance of a good manager to minimise the default risk.

He says: “We have actually been in European high yield for around 18 months. You need an experienced manager, someone who can identify the risk.

“If defaults can be avoided then the returns from European high yield is a place we like to be. Default risk will probably rise at some point but I don’t think it’s bad enough to not consider it at the moment.”

Jones also questions the implied default rates by European corporates, which currently stand at 8 per cent on the investment grade derivatives index for Europe.

He adds: “What is currently priced into European investment grade credit is something twice as bad as anything since 1970.

“Corporates are still implying too many defaults. Either that or we’re going to go through a massive default cycle, which I don’t think is going to happen at this moment in time.”



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