The default level of European high-yield bonds last year was close to 40% because of the high concen...
The default level of European high-yield bonds last year was close to 40% because of the high concentration of telecom stocks in the sector.
James Gledhill, manager of the New Star High Yield fund, says that two years ago, 60%-70% of the European high-yield sector was made up of telecom stocks and these have now been technically wiped out, with Colt Telecom the only company surviving.
As these stocks are cleared out of the index, Gledhill says the sector now looks more attractive as what is left is of much better quality.
Good quality companies that exist in the sector include Focus DIY, Yell and the packaging business Kappa, which was upgraded last week, according to Gledhill.
He says: 'There are also a lot of fallen angels in the sector. Some of these will fall right through to default, but others are going through radical restructuring and will provide diversification to the sector.'
James Foster, fund manager at Isis Asset Management, says the slowdown of the economy has been one of the fundamental factors behind the large number of high-yield defaults.
Over the last 12 to 18 months, Foster says profits have gone into recession, which has driven down the revenues of companies and as a result, many telecom stocks have gone to the wall.
Foster says: 'There has been a lot of deflation in telecom prices, which is the worst possible scenario for high-yield stocks.
'I believe there is a 10% chance of deflation and it may be worth risking some money in gilts in anticipation of this.'
A positive for the high-yield sector is the fact that companies are now cutting dividends, reducing leverages and selling off divisions of their business and focusing on what they are good at, means that their ratings should improve in time, says Foster.
All these policies conserve cash, he says, which is good for the bondholders.
He adds that shareholders are now rewarding companies with conservative balance sheets, as these are the companies that are performing well.
While Foster concedes there is a 10% chance of deflation appearing in European economies, the likelihood of a return to stronger economic growth is far higher.
As confidence begins to recover in the economy, he says, growth should also rebound, which is good news for the high yield area.
Foster says: 'The economic cycle is such that all the bad news has now been priced in and no good news has been priced in. As such when things do begin to improve prices will snap back to more realistic levels.'
David Fancourt, fund manager at M&G Investments, says a few new issues of European high yield bonds are expected this month and in the last week there was a euro issue from the paper and paper-packaging manufacturer Jefferson Smurfit. He says: 'There are a number of different deals coming to market and it is important to discriminate when to invest in high yield. These new deals and issues give more choice and the market is becoming more diversified with more sectors and more names to choose from than in the past.'
Sector is becoming more diversified.
Companies are cutting costs and restructuring.
More issues are coming to market.
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