Tim Dowling, head of Credit Investments & Lead Portfolio Manager Global High Yield at NN Investment Partners
High yield (HY) as an asset class encountered a challenging global environment in the third quarter, mostly the result of a rise in risk aversion among investors. Risky assets such as HY bonds reacted negatively to fears of a perceived global economic growth slowdown led by the world’s second largest economy, China.
HY returns were accompanied by an unusually large divergence between regions. Returns in Europe significantly outperformed those in the US, as the market welcomed a compromise outcome to the latest phase of the Greek crisis and signs of a sustained economic recovery.
US returns were weak, particularly lower down the rating scale. The underperformance of US HY bonds can be mainly explained by the importance in the benchmark of issuers present in the energy and material markets.
More generally, energy, commodity and global growth related credits underperformed on the back of increased worries on Chinese, emerging markets and global growth and falling commodity prices. From a credit quality point of view, there was a clear risk-off trend: higher quality credits outperformed lower quality credits.
In the past months, we witnessed a number of defaults in the US energy sector. Low oil, natural gas and coal prices have caused defaults in the energy and metals & mining sectors, and we believe further defaults will follow.
Fortunately, outside these sectors the default rates remain low, but sentiment for US high yield is unlikely to improve much in the near term as these sectors are sizeable. A key trigger for a reversal would be a bottoming of commodity prices and oil prices in particular.
European high yield is not completely sheltered
In the current environment it is difficult to imagine that the European HY debt category would be completely sheltered from the severe headwinds facing its US counterpart. Indeed, lower oil prices will lead to more defaults in the energy sector. However, this especially holds for the US. The energy sector is about 15% of the US HY market, whereas in Europe the exposure is not more than 2%.
Perhaps a greater risk to European HY are investment flows, which are probably even more important for European than for US HY paper. Whereas US HY has witnessed outflows this year and last, European HY attracted +16% of assets under management in inflows so far in 2015, after inflows of +10% in 2014. Sentiment reversals and subsequent investor outflows are of course potential headwinds for HY paper in the US as well as in Europe.