Euro Junk Bonds Come of Age
February 10, 2010
Last year, euro high-yield bond prices surged by a record 80%, outperforming many other asset classes. Even after these gains, we think the euro market still trades at an attractive level.
Stellar Year for Euro High-Yield Market (Total Return %)
Despite explosive growth in recent years, the euro market is still dwarfed by the US. And euro high yield is also much more concentrated, with 143 issuers at the end of 2009, or less than a fifth of the number in the US. But we believe the European market is entering a rapid growth phase. Its composition is likely to be transformed in the coming years, notably by the entry of many large financial companies that have lost their investment-grade status.
Many of these so-called fallen angels are casualties of the financial market meltdown in 2008, including Royal Bank of Scotland and Commerzbank. Since most fallen angels take several years to recover investment-grade status and undergo at least one high-yield refinancing, we expect these companies to add between €50 billion and €150 billion of supply.
For investors, navigating this changing market will require special expertise, such as knowing how to analyze its structure in order to gauge the effects of sector composition on volatility and returns. And strong issuer-level research is needed to identify the most attractive opportunities.
A careful assessment of the inherent risks is also necessary. For example, the European market still suffers from limited liquidity. Legal ambiguity is another risk, as bankruptcy laws vary from country to country and there is no standard code for how creditors of bankrupt companies should be treated across Europe. But we think these risks can be mitigated by capturing the European opportunity in a diversified global or multisector investment strategy.