Europe is an interesting place for investors, particularly fixed income investors, given the combination of political and macroeconomic events in the region.
The year started with a bang as the European Central Bank (ECB) finally reacted to the threat of deflation, announcing a quantitative easing (QE) programme slightly more ambitious than most people were expecting.
Meanwhile, sluggish growth in many economies and the rise of anti-austerity political parties in countries such as Greece are making the region more challenging, even for strategic bond investors who have an inherent flexibility in their investment approach.
Chris Higham, manager of the Aviva Investors Strategic Bond fund, notes: “The recently announced QE programme by the ECB should underpin credit spreads in the short term. While valuations remain relatively tight on a historical basis, we consider credit attractive, given the extremely low and sometimes negative yields on government bonds.”
He adds: “There is an expectation that QE will give added impetus to investors’ search for yield, with credit likely to benefit. In the high yield space, we prefer having exposure to very large, stable businesses that are less cyclical and more able to weather an economic downturn.”
In BlackRock’s latest fixed income outlook, Michael Krautzberger, head of European fixed income, suggests there are some positive aspects to the market in Europe.
He explains: “Our positive view on European financial credit panned out in 2014, driven by the deleveraging of the banking system. Such positivity has further to run but may slow in 2015.
“Financial corporates should be supported for another year but best value is to be had in subordinated debt, mainly in the core. ‘Additional tier 1s’ struggled in 2014 and face more supply pressure as banks look to meet loss absorption and leverage targets. However, yields of 5–9 per cent in a world of 50 basis point-yielding 10-year bunds make this a place for carry in 2015.”
He adds: “As banks step away, capital markets step in: fixed income investors will have opportunities to provide capital to borrowers historically funded by banks, such as mid-market corporate loans or residential mortgages.”
As somewhere for investors to consider, Mr Higham also highlights the European high yield market as it continues to expand on the back of companies refinancing in the bond markets, rather than replacing bank loans.
“The quality of the companies issuing bonds remains good, with a high proportion of these being BB-rated. However, we are very cautious in our positioning and remain wary of overweighting sectors that are under a lot of pressure, such as food retailers and producers in the UK, where the competitive landscape intensifies and the lower-quality issuers with more leverage on their balance sheets struggle.
“Other factors such as the lower oil price, and whether the US increases rates soon while most of the world is easing, are also at the top of our list in macro discussions as we revisit our investment strategy throughout the year.”
Meanwhile on the political side, the fallout from the results of the Greek election are ongoing, with anti-austerity parties across the region, including in France, awaiting the outcome of the Greek negotiations with the rest of Europe.
Mr Higham acknowledges that political events this year, such as elections in various EU countries, as well as ongoing geopolitical threats worldwide, could disrupt the market in 2015 and increase market volatility.
But he adds: “This will in turn create opportunities to find pockets of good value. For instance, we believe there is significant value in the periphery in companies that have very diverse earnings streams, like Telefónica, and are exposed to various countries and markets other than Spain.
“In terms of the Greek elections, results were in line with market expectations but we are now entering a period of intense negotiations between Europe and the new Greek government. It will be in both parties’ interests for Greece to remain in the eurozone, but we see two major risks on the horizon.
“First, the risk of policy error in the negotiations with Greece; and second, the risk that this outcome could set a negative template for the elections in Spain and other countries where populism and anti-austerity trends are becoming evident.”
Nyree Stewart is features editor at Investment Adviser
