EUROPEAN HIGH YIELD PAPER IS OFFERING ATTRACTVE YIELDS OF 17% BUT WITH IT COMES A HIGHer RISK OF DEFAULT
European high yield bonds are looking attractive as their yields are pushed to highs of around 17%, according to Michael Markham, fund manager, fixed interest at Investec Asset Management.
Markham said that although the risks associated with this type of asset were greater than with equities, government bonds and investment grade corporate bonds, the yields currently available in this sector are even better than in January 1999, which saw a rush to buy high yield corporate paper.
One of the risks in buying this kind of debt, he admitted, is that the risk of default is much higher than with investment grade debt.
He added: 'Yields available on the index at the moment are in excess of 17%. The asset class becomes even more attractive when you realise that the yields available on US Treasuries and bonds have fallen.'
Over the past year, government bonds, such as UK gilts, US Treasuries and German bonds, have outperformed equities as investors have sought a safe haven from falling stock markets. Aberdeen believes Government bonds now look overbought.
Paul Reed, manager of Aberdeen Fixed Interest and Aberdeen High Yield funds, said the high yield market is more susceptible to lower economic growth, with lower earnings having a much more significant impact on a company's ability to service its debt. As a result of recent economic weakness, defaults and rating downgrades have increased dramatically, which has resulted in poor performance, spreads widening, and this in turn has dented sentiment further towards this area of the market, Reed added.
However, with a recovery in global economies, company balance sheets should improve and spreads will begin to narrow.
He noted: 'The high yield sector enjoyed its best ever year in 1991, returning 34.58%, despite a record-high default rate. According to Merrill Lynch, today's extreme spread is far less dependent on the middle and bottom tier credits than was the case in 1991. Consequently, even by favouring more highly rated non-investment grade credits investors can still receive a good level of income. The typical spread on double-B rated bonds is between 300-500 basis points over government paper.'
Markham said one of the factors discouraging is the fall out after high yield's popularity rise in early 1999.
While the market may look similar in terms of opportunities to January 1999, there are some differences that should encourage investors into the market, he believes.
Two years ago, Markham said, both investors and analysts had made the mistake of assuming that the fledgling European high yield bond market would behave in the same manner as the more mature high yield market in the US. However, Europe's growing pains resulted in poorer than expected European high yield returns.
In the US market there were issuances from 60 different industry groups compared to just 16 in Europe.
In fact, he said, the nominal value of the European market at that time was just E5bn, while that of the US was E500bn.
Markham added: 'The situation is now very different. The European market is five times the size it was and now has a nominal value of E25bn, and growing quickly.
There has been an increased focus by companies on shareholder value and a recognition of the benefits of issuing debt, as part of a balanced approach to their business structure.
'Diversity has also now come into the market with 34 distinct industrial groups issuing, with technology, media and telecommunications now accounting for around 40% of the market. Good opportunities to exploit market efficiencies are now available.'
He does not believe that the European high yield market is now like the US, but comparisons between the two are now fairer than they once were.
The market, Markham added, had moved from there being only one sector from which investors could expect very high returns to a market where excellent returns could demonstrably be obtained from other sectors.
The maximum benefit to investors would come from exposure to the high yield market as part of a diverse bonds portfolio, he said.
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