One of the great advantages of this approach is that an event-driven high-yield manager is not trying to predict the direction of the stock market, the economy, interest rates or elections, so is not reliant on picking that opportune moment to invest. The ability to understand industry and company-specific fundamentals as well as the technicalities of bond-specific terms is critical. A successful outcome usually requires patience and an unwavering focus on achieving a clear exit. As Benjamin Benjamin Franklin said: “Diligence is the mother of good luck.”
The key risk is clearly default and therefore companies that exhibit poor management, poor industry fundamentals, disadvantageous competitive positioning or poor financial controls need to be avoided. This is where the destructive nature of asymmetry in this asset class is at its worst.
Although we have witnessed a relentless fall in yields in the past five years since the depths of the credit crisis, we believe that many value opportunities remain in the European high-yield market and particularly in event-driven and special situations credit investing.
Refinancing deals are being completed and the transition from loan to bond financing continues. This, combined with the initial public offerings market heating up, provides exit events for sponsors and catalysts for the re-rating of corporate credit.
Furthermore we are now witnessing the early signs of recovery in Europe which provides a very supportive backdrop for high-yield credit investors – there are more opportunities because of greater number of corporate credit events, combined with fundamental credit improvement. Signs of the recovery can be seen in the graph, sourced from Bloomberg, which shows the progression of the European Purchasing Managers’ Index for the past two quarters:
Fundamentally credit metrics remain solid and, in fact, better than during the previous cycle, and I believe that the single B and CCC rating buckets represent the best risk-adjusted return potential compared to other areas of high yield or investment grade, which are susceptible to duration and interest rate moves. Credit spreads are still pricing in default risk in excess of historical averages and are still substantially wider than before the crisis in 2007.
The record growth in high-yield issuance is providing numerous investment opportunities in both the primary and secondary bond markets. The high-yield market has grown approximately 10-fold since 2001, continues to experience healthy inflows and is expected to grow strongly as more corporates and sponsors access this form of financing compared to loans.
Accordingly I believe that the European high-yield corporate debt market still offers attractive risk-adjusted returns as opposed to other asset classes given the backdrop of low global growth, low interest rates and the gradual withdrawal of central bank liquidity in the coming years. The market environment is well suited to the stockpicking-style investor who has a nimble and adaptive strategy and can access a wide range of opportunities.