Views from fixed income specialists in BNY Mellon boutiques Alcentra, Insight, Mellon Capital, Meriten, Newton and Standish suggest that corporate credit will continue to attract investors, despite a different risk/reward profile than they may be used to, because of the continued gap between yield offered and the income demanded by fixed income investors.
The manager’s Fixed Income Special Report just published has used views from 23 fund managers and investment strategists across the boutiques, and offers an overview of the credit cycle from investment grade to emerging market debt, asset backed securities and catastrophe bonds.
Andy Burgess, Insight Investment product specialist, said: “With developed market yields at historically low levels, many investors are increasingly considering the high yield market for returns, even though investment grade markets may be more attractive on a risk/reward basis.”
Burgess points to volatility in markets off political uncertainty in Europe and oil price concerns, but notes that this may also create investment opportunities in the high yield sector.
Changes in oil prices could in particular drive flows into and out of the US high yield market, because of the challenge seen to US energy companies offering high yield bonds. Burgess sees defaults in the energy sector increasing in late 2015 and early 2016.
Sebastien Poulin and Khuram Sharih, members of Newton’s fixed income team, say new issues of high yield instruments are likely in the US as M&A and leveraged buyout activity is expected to increase. They see opportunity in US ‘BB’ rated paper.
Uli Gerhard, high yield portfolio manager at Insight Investment, said that recent new issuance in Europe has generally been of poor quality and many companies’ capital structures are only viable in an environment of economic growth rather than stagnation. That said, if the ECB QE programme leades to lower government bond yields, then demand for high yield will increase, further squeezing yield spreads in this area.
Paul Brain of Newton takes a slightly different view: he warns that investors should adopt a cautious approach to high yield this year.
“In high-yield markets, the limited refinancing requirements of issuers may provide attractive medium-term opportunities but a cautious approach is merited. The vulnerability of US shale oil companies – which now comprise a notable part of the US high-yield index – to falling crude prices threatens to increase default rates.”
Paul Hatfield, Alcentra’s chief investment officer, is positive on the prospects for the global loans market.
“In our view relative value is tilting in favour of US versus European loans. But in both markets we expect to see quite a heavy uptick in volumes in 2015, particularly from M&A related activity. Right now we would remain overweight on the US but with a good chunk of European loans as well.”
Default remains a threat to the loan market, but Hatfield expects a benign year.
“Default levels may go up slightly this year but not to the level that would cause many investors sleepless nights. The default environment is very benign in the loan universe within northwest Europe and the US where we are lending and recent market polls have put the likely US default rate well below 2.3% for the next couple of years.”