HY & IG bonds still attractive

Slower growth and central bank policies supported risky assets last month. The HY segment rallied after more easing from the ECB and the Fed skipping its March hike. So far, € HY has strongly outperformed € equities. At the beginning of May, risky assets ended 11 consecutive weeks of positive performance. Thus credit still delivered a more attractive return than risk-free assets.

The US HY is still a top performer, closely followed by the EUR HY. Moreover, default rates in the US & EUR corporate markets have stabilized to, respectively, 4.5% and 2%.

Last month, we saw a good performance of hybrid debt. Senior secured & unsecured outperformed subordinated debt & Cocos.

Sector selection remains key, with basic resources outperforming.

European bank fundamentals remained in good shape, with Core Equity Tier 1 ratio reaching 12.5% and non-performing loans decreasing to 4.6% end-2015.

The European Institutions are currently more resilient than in the past. Capital and asset quality are improving, although some specific fears on an individual level could be justified regarding commodity exposure and the business model.

All in all, from a bondholder’s perspective, the banking sector – subordinated debt, in particular – is attractive.

While the inclusion of non-bank corporations in the CSPP asset purchase programme is very positive for corporates established in Europe, the modest deposit rate cut and new attractive funding facilities will support the banking sector, principally peripheral names. Financial subordinated debt will, by extension, benefit from the search for yield.

AT1 and T2 markets will certainly reopen thanks to this improving risk sentiment (BNP, HSBC, Santander, Unicredit do not yet meet the 1.5% bucket requirement).

Within the financial sector, we have a preference for subordinated debt (LT 2) over senior debt. The carry-to-risk is more attractive for LT2 in an environment where banking issuers are trading at lower levels than non-financial issuers.

In the non-financial space, we prefer sectors less sensitive to the cycle such as Telecommunications and Utilities. The former has experienced a positive growth dynamic during the last 4 quarters, with solid margins (around 40%).

The latest consolidation trend has also pushed the price up. The latter is less dependent on commodity-exposed assets (the EBITDA derived from those assets falling from 75% at the top to 45%). It also offers exposure to non-core, high-beta issuers still offering an attractive yield pick-up.

Drying-up of HY issuances, with IG issuance well-oriented

On the global HY segment, we have seen a drying-up of issuances since the beginning of the year in the US as well as in the euro zone.

Indeed, in early May, corporate US HY bond issuance activity represented $60bn ytd vs $260bn in 2015. The situation is similar on the EUR HY market (€10bn ytd vs €65bn in 2015). There are fewer and fewer opportunities in the HY markets.

On the contrary, both the US & EUR IG corporate bond markets have experienced a real flood of issuance. In fact, more than one-third of the 2015 volume had been issued as at the end of April 2016 (€200bn Ytd vs €500bn in 2015, $400bn Ytd vs $1200bn in 2015).

This movement could still increase with the new European Central Bank measures. Indeed, the Bank has already specified the details of its CSPP.

The ECB is committed to purchasing IG euro-denominated bonds with maturities ranging from 6 months to 31 years, both on the primary and secondary markets, issued by non-bank corporations established in the euro area.

So far, US companies represent more than 26% of EUR IG issaunce, and this movement could intensify in the coming months, supporting the IG market in Europe.

To sum up, there are still attractive opportunities on the US IG & HY markets, as exemplified by the drying up of the HY market. Investors absorbed rapidly each new issuance.

Neutral stance on Convertible & Covered Bonds

We are still looking for an entry point into the convertible market. We still assume that primary issuance will be low this year and that 10% of the market could be redeemed. From a more granular viewpoint, IG convertible bonds, unlike non-IG convertible bonds, are close to fair value and the HY asset class is outperforming the others. Finally, volatility is at a fair level, around 30%.

As with convertible bonds, we still notice a negative net supply on the covered bond markets, despite a surge of 56% in the first quarter and a rally on peripherals, driven by the ECB buying spree and leading to a strong performance over govies, thanks to the CSPP. However, it is too late and, indeed, expensive, to buy peripherals. Our intention was to stay neutral until June.