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June 2019 | GSAM Connect

Embrace the Staycation: Investing in the European “Everyday Economy”

Europe can offer Yield: The recent rally in rates and spreads saw euro-denominated debt trading with a negative yield reach a record high of 40% for outstanding sovereign debt and nearly 20% for index-eligible corporate debt1. What’s more, negative yielding debt is no longer confined to high-quality and short-duration debt; the universe has broadened to include bonds with lower ratings within the investment grade market and longer maturities. Potential upcoming European Central Bank (ECB) easing could see this universe expand further.

During prior periods of rising negative-yielding debt, European investors sought yield across the Atlantic in US fixed income. In today’s environment of higher currency-hedging costs (given the wide gap between US and European short-term rates) we think it is wiser for investors to embrace a “staycation” and invest in European fixed income. In particular, we see value in European High Yield which currently offers a yield of 4.4%. We also believe global bond investors can access European High Yield as an attractive complement to existing US High Yield allocations.

Recognizing and Realizing Relative Value: European High Yield is modestly more levered than its Investment Grade counterpart but offers a relatively attractive spread premium of 269bps, which equates to almost three times more spread per turn of leverage, a measure of a company’s credit worthiness. The sector also appears attractive relative to the US market, offering slightly more spread per turn of leverage than US High Yield.

Downward Drift in Defaults: Policy “puts”—namely actions that support market liquidity—alongside contained inflation has helped to keep a lid on default activity, with the last twelve month par weighted default rate for European High Yield hovering around 2%. To gauge market confidence in low default activity persisting we review the proportion of bonds trading with a par value below €80. In Europe, this stands at 3.8%. This is almost three times lower than the 11.7% average observed between 1999 and 2015 i.e. the period prior to the ECB engaging in quantitative easing. Looking ahead, we are mindful of rising wage inflation which could create profit margin pressures. That said, it is also worth recognizing that companies have taken advantage of historically low yields by issuing long-dated debt. This affords European High yield issuers time to remedy balance sheets and adapt to cyclical and structural shifts.

Investing in the “Everyday Economy”: Migration down the credit rating spectrum requires astute security selection, particularly as the policy and macro backdrop drives greater dispersion between strong and weak balance sheets. Our specialist investment team draws on local insights to unveil attractive opportunities in the “Everyday Economy”, investing in an array of European High Yield issuers, ranging from firms responsible for delivering high-speed internet in an increasingly connected world to socially responsible companies making recyclable milk cartons.

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May 2019 | GSAM Connect
Assessing The Impact of Tariffs on High Yield: As Much Art as Science

We believe US trade protectionism is a sector-specific story for the US High Yield corporate credit market but with limited direct implications. That said, indirect impacts such as lower consumer and business sentiment could dampen economic activity and cloud the outlook for credit markets.

April 2019 | GSAM Connect
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Firm retail investor demand has been a large contributor to US High Yield corporate credit performance this year. Much of this demand is channelled through exchange traded funds (ETFs) which has resulted in performance dispersion between bonds from small and large issues, as only the latter tend to be eligible for ETF inclusion.