Outlook For European High Yield Credit

By Louis Gargour, Manager of the LNG Europa Credit Fund

Market activity in 2013 supports the rationale for investing in Western European High Yield Credit into 2014 and beyond. The ECB has committed to keeping its benchmark interest rates low for 2014, and the rate cut in November to 0.25% substantiates that view. We view their accommodative policy as supportive to the broader pan-European financial system as well as funding access to  peripheral Europe, until such time as “non-ECB liquidity-fueled growth” and inflation come back into the system. Average peripheral sovereign yields (Italy, Spain and Portugal) are now at 3.4% (down from 7.8%), which goes to show that yield compression has already taken place, and sovereign bond refinancing and funding needs are being executed at manageable levels.

Focusing on Western European high yield corporates, single-B spreads have rallied from 800bps to 440bps in 2013. Given the significant shift in risk premia, we anticipate further spread tightening for 2014 within the asset class. The European high yield corporate maturity wall has been significantly pushed back with only €33bn of maturities due in 2014 and €30bn of maturities due in 2015.  This level is manageable and over 80% of the maturities are in low duration, high quality names. We expect a strong and significant pipeline of new entrants into the market for 2014, this giving rise to new potential opportunities due to the expansion of the European high yield market. Default rates continue to tick lower at 1.5% in Western Europe.

We continue to identify and invest in dislocated opportunities within liquid high yield and event driven strategies. As spreads compress within corporate credit, the managers of LNG Capital are focusing more on exploring idiosyncratic opportunities, both on a long and short basis.  These components of the portfolio are expected to generate “equity-like returns” from a combination of augmented portfolio yield, and cash price appreciation.