European Investors Favour High Yield, but Wary of Outlook

European fixed-income investors prefer to invest in high yield bonds (HYBs) relative to other sectors according to Fitch Ratings’ quarterly credit market investor survey. HYBs consolidated its popularity as the most favoured sector, with 21% of fund managers voting it their top investment choice.

The credit ratings agency (CRA) said that the percentage is only marginally down on the 24% in Q212, and comfortably higher than the 14% recorded in Q112. As a result, HYBs stayed ahead of runners-up financial and non-financial corporates, voted the top choice by 17% and 16% of respondents, respectively.

At the same time, investors’ outlook for HYB credit conditions remains negative, according to the survey results. In fact, a greater proportion of fund managers (51%) expect conditions to deteriorate, up from 37% in the Q212 survey, while 40% of investors expect HYB issuance to increase, marginally down from 42% last quarter.

Survey respondents have also become more pessimistic on the outlook for commercial bank lending standards for speculative-grade companies: 38% said standards will tighten further, reversing the more optimistic trend of the last two quarters since the European Central Bank’s (ECB) long-term refinancing operation (LTRO).

Fitch believes that European HYBs will continue to receive support despite difficult markets, as investors who may be intolerant of low or negatively yielding European sovereign debt seek to bolster returns. The asset class outperforms even emerging-market bonds year to date, a pattern which has not happened since 2009 – contrary to the ‘sell’ signal that recent negative monthly fund flows for the asset class suggests. May and June saw two consecutive monthly outflows totalling €2.4bn, the first outflows since November 2011.

Total return performance for European HYBs touched 15.3% for the year to 10 August, outpacing emerging market corporate and sovereign debt (13.2%) for the first time since 2009, and trumping US high yield (9.3%). Developed market non-financial issuers reduced their supply of new bonds to €10.8bn in Q212, down from €23.2bn in the first quarter, as risk premia widened. The European HYB default rate remains low, at 1.3% for the trailing 12 months to end-Q212, but appears set to rise amid renewed growth concerns.

The disconnect is that investors seem happy to retain existing holdings, while remaining reluctant to buy into new issues, the CRA concludes. Hence secondary market returns remain comparatively high, while primary new issue volumes remain anaemic. Everything is fine for the well-known, frequent BB issuers with existing investor bases. By contrast, a first-time issuer, or B-rated company, has to pay a high spread premium.

The Q312 survey was conducted between 2 July and 2 August, and represents the views of managers of an estimated US$7.2 trillion of fixed-income assets.

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