Over the past few years, the high yield market has had a great run. The BofA Merrill Lynch Global High Yield Index returned 156.5 per centin sterling from the trough of the market in mid-October 2008 to mid-October 2014. An even more impressive result when you think that the FTSE All Share (ex ITs) returned 93.8 per centover the same period, and gilts 47.8%.
If the market has had a strong run, we need to ask if there are still pockets of opportunity left to pursue?
The high yield market has become a respectable place for investors over the past 15—20 years. Lower absolute yields have helped make it less speculative, broadening the appeal for both issuing companies and mainstream investors. In a world of low interest rates, higher relative returns have added to the attraction.
Since 2008 this process has sped up. We are all familiar with the trend of banks reducing their loan books to get their balance sheets down to manageable levels. In the Eurozone, bank lending to corporates has fallen by 9.3 per centsince the peak in 2011. The best companies that in the past relied on bank lending are now coming to the bond market, for the most part fitting into the B—BB area. In many cases, these are strong companies with robust financials and compelling prospects.
One example is Bibby Offshore, a UK company with nearly 40 years’ experience in the offshore oil and gas sector. They have an issue for 175 million sterling, rated B-plus, paying a yield of 7%. Another example is Hyva, which manufactures hydraulic parts for trucks. It is a Dutch company with over 60 per centof sales in Asia. It has a US$350m bond on issue, paying a coupon of 8.7 per centand currently yielding 8.1%.
We refer to these and similar companies as the ‘middle market’ as their typical issue sizes are forming a new, middle layer in the market, usually in the €150m–€350m range that is too small for the mega-funds. But there is another side to the story. As we mentioned, the reason these companies are moving from bank lending to the bond market is due to the banks improving their balance sheets. And this is opening out a second opportunity.
UniCredit, for example, an Italian bank with significant interests in German-speaking markets, has around 40 million customers, offering a full spectrum of services. Unicredit’s balance sheet has improved enormously over the last year resulting in a €712m profit for Q1 2014 and core capital ratio of 9.72%. It is currently paying a yield of 7.3%. Credit Agricole is the largest retail bank in France, a ‘national champion’ with 49 million customers, total assets in excess of €1.5trn and a 2013 profit of €2.5bn. It maintains a strong balance sheet and a core capital ratio of 9.6%. It also pays a yield of 7.3%.
These companies offer a number of important diversifying characteristics, including currency and geography. As a whole, the high yield market has certainly had a good run. But within the market there remain good opportunities, paying good returns to income investors.
Christine Johnson and Bastian Wagner are fund managers on the Old Mutual Monthly Income High Yield Bond fund