10th November 2011
Henderson points out investors began moving their money out of the asset class in June, with an outflow of $391m. This trend continued with outflows of $183m, $1.12bn and $567m in July, August and September respectively.
But there are tentative signs of a recovery. The US high yield sector was already seeing stronger fund flows from investors, who have finally decided that it is worth taking the risks for the yields on offer (as high as 9-10% in some cases). Data from EPFR Global suggests that the European market is now also improving. After a brief hiatus, high yield issuance also appears to be off to the races again, both in Europe and the US.
Henderson's fixed income team noted that for the week ending 19 October Western European high yield funds saw inflows of $260m, according to data from Emerging Portfolio Fund Research (EPFR): "This marks the largest inflow of the year and the largest absolute inflow since EPFR started tracking the figures at the end of 2004. In the US, an impressive inflow into high yield funds of $2.1bn was recorded for the week ended 19 October, again the largest figure since EPFR began tracking the measure."
High yield may be resuming a trend that started at the beginning of 2011, when the sector was benefiting from a structural trend among companies towards taking on debt through the capital markets rather than through banks.
This had a number of implications. It meant that companies generally secured longer-term and more secure financing, albeit at high rates. As a result, companies had more predictable financing costs. It also provided investors with a greater choice of issuers.
It also improved the ‘quality' of the companies. This article suggests that the weakness in the European high yield market may cause re-financing problems, but it also makes it clear that the profile of the debt for high yield companies has improved: "Compared with 2010, the region's speculative-grade-rated companies have improved their maturity profile. The total amount of debt outstanding in the category amounts to $601 billion, up $100 billion compared with last year, but that is mainly due to first-time issuers accessing the high-yield market.
"A total of $325 billion of debt needs to be refinanced between 2012 and 2015, or 54% of total outstanding debt, compared with 63% a year ago. In 2012, $66 billion needs to be refinanced, down from $83 billion. The shift in maturities reflects the substitution of bank debt with high-yield bond issuance, Moody's said."
These changes are all still in place, but the market became spooked over the potential for defaults if the Eurozone crisis escalates. It may have recovered slightly, but it is still pricing in considerable margin for error. This piece quotes Loïc Fery, managing partner at credit manager Chenavari Investment Managers (one of a number of hedge funds heavily invested in this part of the market) saying: "The iTraxx Europe Crossover Index, which shows the spreads on European high-yield debt, is trading at 750 basis points. This shows an implied cumulative default probability of 40%-50% over the next five years, assuming a recovery rate of 50%. This means if you do not believe one out of two high-yield companies will default over the next five years, you will be very well compensated for the risk of investing in European high yield."
The sector will undoubtedly see some turbulence over the next few weeks as the Eurozone crisis resolves (or otherwise). But the current implied level of default and low valuations allow some leeway. It appears that some of the smarter institutional investors are already getting in on the act.
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