Navigating the potential of European high-yield bonds

European high-yield bonds have been resilient so far in 2023. According to Abrdn, the regional banking crisis in the US and the Credit Suisse debacle caused a period of volatility in these bonds. Other potential problems include the impact of rising rates, higher inflation, and a weak economic outlook. However, despite these headwinds, the asset manager remains broadly positive.

This is because Abrdn feels that the available yield more than compensates for the risks involved. Peter Marsland, Investment Specialist at Abrdn, explains that approximately 40% of the yield is derived from the underlying European government bond yield curve, while the remaining 60% of the yield is comprised of the credit spread.

Marsland informs that at 4.46%, the spread of the European high-yield bonds is well above the 10-year average of 4.05%. He predicts that the additional return adequately offsets the current default outlook. “We forecast that the actual default experience will be more benign. Investors should also consider the recovery rate in the event of a company default, which has historically been around 50%,” opines Marsland.

Additionally, Abrdn states that in case of a recession, the central bank would make rate cutes, and government yields will fall. The asset manager contends that this would allow investors to enjoy high returns due to capital gains. Against this backdrop, Abrdn is confident that European high yield would provide positive returns over the medium term.

Discussing maturities, Marsland notes that by the end of 2024, fewer than 20% of the market will reach maturity, with the majority of maturities scheduled for 2026. This provides companies with the opportunity to wait until central banks have concluded their rate hike cycle and financing costs have decreased.

According to Marsland, it is important to focus on the fundamentals of the issuing company. Hence, he recommends that investors fully understand the companies to which they are lending capital. “We believe an active management approach can add significant value in this environment,” says Marsland.

Furthermore, Abrdn contends that the European high yield compares favourably to the US high yield in economic turbulence due to its relatively low-risk profile. The asset manager further says there could either be a marked slowdown or the central banks can deliver a soft landing.

“Whichever scenario prevails, European High Yield, with its balance of credit risk and duration sensitivity, could deliver positive outcomes for investors over the medium term,” concludes Marsland.

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