The latest issue of The Cerulli Edge – Europe Edition notes that the European high yield sector has “mushroomed” since 2009, more than doubling in size over the four years ending April 2013.
Despite growing quicker than its US counterpart the market remains just one-third the size ($362bn versus $1.1trn), and Cerulli says it poses investor risks that its transatlantic cousin does not.
For example, while the US has uniform bankruptcy rules, European high yield investors face a range of differing legal systems – raising the risk that “a French or Spanish judge may place workers (and their wage claims) higher than unsecured bond holders if a business goes to the wall.”
In addition, fallen angels – firms which have dropped from investment grade to high yield – have skewed the European market. Car manufacturers form 15% of the sector, compared with 2% in the US, while domestically-focused banks from the eurozone periphery also feature in large numbers.
The European market dipped less than its US counterpart during this year’s high yield sell-off – prompted by fears the US would begin “tapering” its quantitative easing programme. But Cerulli argues that this was “neither a sign of resilience nor that corporate Europe is in recovery mode.”
Indeed, the firm warns that European high yield may be in what Henderson Global Investors calls “a complacency bubble”, where relief over an apparent stabilisation of the eurozone debt crisis has pushed up corporate bond values, rather than the fundamentals of the bonds themselves.
While fund managers have adjusted their European high yield strategies and benchmarks to mitigate risk, less-discerning investors may find themselves exposed in a more prolonged sell-off.
‘Benchmark huggers face losses’
“It is difficult to predict when Europe’s love affair with bonds will fizzle out, but investors need to be disciplined as new issuances surge,” wrote Yoon Ng, a Cerulli associate director.
“The European high yield market has grown fast — and flabby at the edges. Benchmark huggers face losses and liquidity constraints if outflows pick up. A strategic rethink may be necessary to avoid being caught out.”
Expert Investor Europe data shows that fund selector appetite for high yield has declined this year, from the elevated levels seen in 2012. For example, at our Madrid conference in June, more than half of investors expected to reduce their high yield exposure over the following 12 months.
Platinum members can see how investor appetite for high yield and other asset classes has changed over time, using the Country Data Summaries links on the right-hand side of The Data Centre.