European sub-investment grade paper is offering high yields but the risks appear moderate, according...
European sub-investment grade paper is offering high yields but the risks appear moderate, according to John Hatherly, head of global analysis at M&G.
Hatherly says whereas only 20% of investment grade corporate bonds sensitivity is based on company performance, sub-investment grade corporate bonds (BBB and less rated) are almost completely reliant on company performance and the market, he says.
Within the sub-investment grade corporate bonds sector, there are some attractive yields offered in the UK and Europe. He says: "There is always a greater yield with greater risk and we have seen a considerable rise in yields recently. The spread on sub-investment grade corporate bonds has been getting back up to levels not seen since September 1998, during the Russia crisis. Spreads have risen by around 800 basis points due to default prospects in the US and elsewhere. Risks, which may never happen are being discounted."
If these negatives do not occur, then Hatherly believes there is room for some very healthy returns, especially with inflation as it is. He adds: "There is a general fear of new issues. With these negatives balancing out, the stable inflationary background, plus the high yields means there are some potentially massive returns in European sub-investment grade."
Bonds on the whole have been revitialised recently as investors sought their relatively stable returns at a time when market volatility has been high, Hatherly says. He highlights some positive factors for European government bonds: "Firstly, inflation is 2.2% in the UK and 2.7% in the euro zone, which is fairly low. The authorities have kept the pressure on inflation and rates should change from the current 6%. We may see an increase on the continent, where rates are currently 4.75%."
Additionally, he notes that government public sector spending is also coming under control. He says: "There is a lessened supply of eurozone government bonds. Yields are currently around 5%, which is reasonable and indicates a positive outlook."
Bob Attridge, head of fixed interest at Old Mutual is positive on European government bonds as a whole, although admits with the weakened euro it is difficult to ascertain which end of the curve is more attractive.
Attridge suspects the ECB will try to enhance the credibility of the euro, even at the expense of growth, which means interest rates could increase more than expected. He says: "Small government deficits may mean a flattening of curves, moving towards inversion. Therefore it is hard to call which end of the curve is advisable. There is some long-dated new issuance, so after this year the longer end might be more attractive."
Old Mutual has holdings in the seven to 10 year part of the curve and holds some short-ended eurozone government bonds.
Attridge says: "We are not involved in corporate bonds, at present, as government finance is improving. The introduction of the euro is still fairly recent and has been suffering from scarcity value, which is why Old Mutual remains nervous of corporate bonds."
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