Junk bonds. That’s the rather off-putting name for high-yield bonds. In contrast to its US counterpart, the market for European junk bonds was barely taken seriously for many decades. Yet times have changed.
Senior portfolio manager at Kempen Rik den Hartog is responsible for Euro High Yield together with his colleagues in the Credit Team. For years, high yield was the territory of the US dollar. ‘The European market was simply too small to act as a robust fund universe,’ Den Hartog says. He believes that those days are over and that it’s now too big to be ignored. The market for Euro High Yield has grown enormously since the 2008–2009 financial crisis. ‘As of year-end 2019 it had quadrupled in size to over 300 billion euros and the number of issuers had doubled*. This is of course also because companies wish to reduce their reliance on traditional banks and increasingly arrange financing via the capital market.›
‘And’, Den Hartog continues, ‘the growth in Euro High Yield shows no sign of coming to an end. In the Eurozone banks account for three quarters of lending to companies, compared to one third for US companies. This persisting trend of moving away from financing provided by banks and turning to the capital market instead will boost growth on the Euro High Yield market.’ This is what he believes makes Euro High Yield a solid alternative to its big American brother.
Europe versus the US
Rik Den Hartog identifies a number of significant differences between Europe and the US. ‘The rating distribution is the most obvious difference. Over 70 percent of the market in Europe holds a BB rating, while this figure stands at less than 50 percent for the US dollar high yield market. At the lower end of the quality spectrum the portion of companies with a CCC rating or lower is over 10 percent in the US, but this is just 5 percent in Europe.’
The sector distribution is also different according to Den Hartog. ‘The energy and health sectors dominate the US dollar market, while the industrial and banking sectors are larger in Europe. Moreover, the Euro high yield market holds a wider distribution in terms of seniority. In Europe, high yield contains more subordinated loans and hybrid bonds issued by non-financial companies, while this is not the case in the US dollar high yield market. In summary, the Euro high yield market is higher in quality and more diversified across sectors and seniorities.’ Furthermore, liquidity levels are sound in Europe, especially compared to other high yield asset classes. Den Hartog: ‘There’s an active market in trading high yield bonds. The average sensitivity to interest rates is low, with durations of three to four years.
‘Incidentally,’ Den Hartog adds, ‘fans of US dollar high yield will say that European growth is all well and good but that the US market is still four times larger. They have a point, but the high yield market in Europe has now grown large enough to demand a specialist approach. Why would you trade regionally in investment grade (credits with ratings of BBB and higher) and not high yield?’
* ICE Bond indices, per 31 December 2019.