The low growth, low yield environment in which investors find themselves shows little sign of changing in the short-to-medium-term.
For those seeking income, the options are limited among assets traditionally held in portfolios for these purposes, such as government bonds and higher yielding UK equities.
UK gilts are paying very little interest, while the volatility of equities, real threat of negative returns and risks to the sustainability of many higher yielding stocks’ dividend payments in a low growth economy, mean they offer little upside but plenty of downside risk.
So where should investors be looking instead? An allocation to European high yield could help investors solve the dilemma of how to generate a reliable and low volatility income stream.
Why is now a good time for European high yield?
Last year, European high yield, as measured by the relevant Bank of America Merrill Lynch index, delivered a fairly unremarkable 0.75 per cent, yet some fund managers were able to outperform this return by considerable margins, perhaps fourfold or more, with significantly lower volatility than the index’s 5.92 per cent.
The conditions in 2016, particularly following the ECB’s latest stimulus measures, have created a better environment for the asset class, meaning we are likely to see a higher benchmark return than last, while good quality active fund managers should be able to do better still.
In Europe, as in much of the developed world, high levels of debt and low economic productivity have been persistent problems for many years. The ECB’s introduction of negative interest rates and expanded QE programme that will include buying investment grade corporate credit, will have various net positive effects and so have been broadly welcomed by markets.
They signal that interest rates will remain lower for longer, easing fears of any major sovereign defaults and possible knock-on effects across the eurozone. The ECB had thus demonstrated, again, its willingness to take meaningful steps to fend off the threats of deflation and recession.
|EUROPEAN HIGH YIELD WHAT TO EXPECT|
Erick Muller from Muzinich & Co explains: “If you consider the FTSE 100 index was yielding around 4.18 per cent (as at Feb 29), a well-managed European high yield portfolio should be yielding somewhere around or just above 5 per cent.
“And though yield is important, total return and capital preservation is generally more so. Let’s not forget that the total return of the FTSE 100 index in 2015 was negative and volatility well into double figures, while a well-managed European high yield portfolio would have given investors a positive total return of close to 4 per cent with a volatility figure below that.
“What does this tell us? That investors have not been compensated for the higher risk they are taking for investing in equities, while European high yield debt has outperformed on the main measures of yield, total return and volatility and the conditions are set for it to continue to do so.
“As such, on a total return basis, a mid-to-high single digit return from European high yield could be expected over the next 12 months.”