European credit seen luring Asian investors
With investors in emerging market credit spooked by US taper talk and releveraging among American companies, Asian interest in European junk bonds continues to rise, say asset managers.
The asset class posted returns of 8.8% plus Libor last year, while investment grade returned 2.4% over Libor, according to Bank of America Merrill Lynch.
Some European fund houses with an Asian presence benefited as a result. Of the $17 billion in global net flows into Amundi’s European high-yield strategies in 2013, $3 billion came from Asian investors, says Laurent Bertiau, global head of sales at the French firm.
“Following the crisis in 2008 and subsequent uncertainty in the market, it’s good to have products that can deliver 3-4% over inflation, isn’t it?" he says. "People have to understand that 10%, 15% or 20% return is not easily achievable, and it may lead investors to take unnecessary risk.”
Other fund houses, such as Fidelity and M&G, have also reported growing interest in European debt, but they decline to provide figures.
“We’re seeing increasing attention from large asset owners in Asia looking at European fixed income strategies,” says Andrew Hendry, Asia managing director at M&G.
On a recent visit to Asia, Richard Ryan, a senior fund manager at the same firm, noted rising interest in European fixed income. “We are not finding the conversation difficult.” He also points to the eurozone recovery as a positive for investors in European credit.
Banks in Europe are continuing to deleverage in response to tighter regulation and capital requirements. Their shedding of risky assets and non-core business lines, and in some jurisdictions turning to the equity markets for fresh capital, all point towards a gradual strengthening of the financial system, says Ryan.
Moreover, European companies previously reliant on bank lending for financing are now looking at issuing debt, some for the first time, thereby increasing the options for investors.
Europe’s stabilisation cycle contrasts to the situation in the US, where many corporates are adding risk by doing more M&A and share-buyback deals – all of which are credit-negative and strain the balance sheet, raising the risks of debt default, adds Ryan.
Yet he urges caution. European high yield is becoming increasingly risky, says Ryan. Amid low interest rates, investors are reaching for yield without thinking about the risk that comes with it.
With high yield, “you are much closer to the events of default than investment grade, and current pricing levels offer little in the way of compensation for these heightened risks”, Ryan says.
Opportunities still exist in European investment grade, he adds, but the returns will not be “exceptional” compared to those of other fixed income markets. M&G forecasts that high-yield returns will be 5.2% for 2014, while those for investment grade will be at least 2%.
“I am not going to say that the valuations are in their own right so attractive that we should all be jumping in,” Ryan says. “But if the investors hold global assets for diversification purposes or other reasons, then Europe warrants consideration.”
Gregor Carle, Hong Kong-based investment director at Fidelity, thinks European fixed income is a better bet than US debt. He notes that European interest rates are likely to be on hold for longer than those in the US.
“If you have concerns about duration in your portfolio and the effect of potential interest rate rises, near term the euro may be a more attractive place to invest [than the US],” he says.
Yet Carle also favours Asian junk bonds. “If you look at the Asian high-yield space, it is staggering to me, at these yields, that there are not more investors considering it worth investing in. Judgment is clouded by the view of what’s going to happen in China.”
“You’ve got to paint a pretty gloomy scenario on China not to see some value in the Asian high-yield space,” adds Carle.
HSBC’s Asian high-yield corporate bond index was yielding 7.3% as of yesterday.