Meagre coupons

The past few years of financial repression, and an unstoppable bond market rally, have shrunk coupon income. Duration has helped total returns, especially among the BBs - despite lower duration of the asset class - and the “high” in high yield has increasingly becoming a misnomer, at least in the euro area.

We now have companies such as B-rated Eircom issuing at 1.75 per cent or BB-rated CCK offering a meagre 0.75 per cent coupon. 

With very few exceptions, every round of refinancing from an existing issuer has seen significant repricing of the coupon on offer, which bodes poorly for medium-term outlook for European high yield companies’ total returns. 

Low interest costs benefit refinancing

But it’s not all doom and gloom for European high yield investors. On a relative basis, when compared to negative bank deposit rates and negative yielding bunds, 4 per cent on Euro high yield is an attractive level of income. 

Another positive is that low refinancing rates have helped improve the outlook for corporate default rates. Defaults are a significant concern for high yield investors, but lower interest costs have boosted debt service ability and have termed out the maturity wall, both of which overall help improve issuer liquidity. 

Leaving aside secondary trading and looking solely at the primary market opportunities in 2019, we believe there have been good investable credits with above-average coupons that, even on a simple assumption of holding to maturity or first call, should deliver attractive returns

Not all ‘Bah Humbug’

Looking into the new year, we believe there are plenty of opportunities for active managers to pick up selected credits with attractive coupons despite this environment. These would include moving down the capital structure for the names in which we have high conviction in, unloved turnaround stories, interesting emerging market names that have to pay for market access, and esoteric new names less known to the market. 

Andrei Gorodilov

Andrei Gorodilov

Portfolio Manager