Expectations are rising for European high yield bonds to outperform in the second half of 2002. Dr...
Expectations are rising for European high yield bonds to outperform in the second half of 2002.
Drawing parallels with the 1990-91 US recession, Jim Leaviss, head of retail and institutional fixed interest at M&G, expects default rates to peak toward the end of the first half of next year, sparking a period of outperformance from the sector as risk aversion slowly dissipates.
At the height of the last US recession in 1991, he notes, sub-investment grade bonds peaked at yields of up to 40%. Following the peaking of default rates, the asset class went on to outperform over the medium term.
Leaviss says: 'Using our own estimates and those of the major ratings agencies, we think we will see default rates peak some time during the first half of next year.'
Following a torrid September, exacerbated by the terrorist attacks on the US, the European high-yield arena posted a double-digit decline but Leaviss believes signs of recovery have been evident throughout October.
'The market has already started to rally but we need to see that default rates are peaking,' he says.
October saw positive newsflow from the telecommunications sector, with rumours spreading about a possible takeover of Colt Telecom and mobile operator KPN Quest posting good results. According to Leaviss, a number of telecommunications companies, including Level 3 and UPC, started to buy back their outstanding high yielding debt.
Jake Newman, fund manager at Rothschild Asset Management, believes that while debt buybacks can be a very positive move for the company involved, they represent a double-edged sword to the bondholder.
'If a company is using its liquidity to buy back its bonds at a discount, it will have less liquidity to put into capital spending looking forward but it indicates management confidence that liquidity will become available soon,' he says.
Jana Benesova, fund manager at Credit Suisse Asset Management, is wary of calling last month's bounce a rally, believing the gains were a result of technical factors rather than any significant improvement in fundamentals.
She says: 'The number of debt buybacks is a theme giving huge support to bond prices. It is a positive but not a turnaround. It is more technical than fundamental and we need a stronger catalyst for change in the broader market.'
Although these companies restructuring their balance sheets may provide a temporary boost to bond prices, it does not mean their earnings will be any better, she adds.
Industrials have been less volatile than the telecommunications sector, according to Leaviss, avoiding the sell-off that befell telecommunications. He says macro factors have still hit the sector though, with falling demand amid a backdrop of economic contraction hitting profits.
Newman believes there is a divide in the industrials sector, with a flight to quality and cyclical factors taking their toll.
He says: 'If you are very careful, you can find value. There are some industrials trading substantially above their redemption value but some of the more cyclical names have shown weakness and are trading below par.'
October bounce in high yield sector.
Value among industrial names.
Default rates are still low.
Two global vehicles
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