Donald Phillips

Transatlantic valuation blues

Donald Phillips

Since we launched the Global Fixed Income Fund range at Liontrust in mid-2018, European high yield bonds have offered more value in spread, the premium over government debt, than their US dollar counterparts.

Apart from a fleeting moment when most of us were still on Christmas holidays, when US high yield significantly underperformed as negative sentiment, combined with holiday-style liquidity, caused a short-lived spike in US spreads, this relative value dynamic has remained consistent.

Until now, that is. In recent weeks, European high yield has outperformed and today in aggregate, offers less spread than US paper (to avoid credit quality differences skewing the comparison, we have used the BB rating band in each market).

Eur BB spread less USD BB spread 

We believe the recent outperformance of European BBs can largely be attributed to the actions/rhetoric of the European Central Bank (ECB), which has once again put a quantitative easing (QE) rocket in the backpack of all things eurozone.

It now feels we are back to the days of bad news equals good news: any data pointing to slowing growth (which, theoretically, is bad for an asset class like high yield) is in fact good news because it stokes the ‘greater fool theory’ that the ECB has our backs.

For us, US high yield is far closer to fair value than its Euro counterpart. The yield on European high yield (again, represented by BBs) has fallen below 2%, while US BBs yield more than 4.5%. Many will argue that relative yield across the Atlantic is a moot point, as hedging your bonds against currency risk means the yield differential comes out in the wash. This is indeed true, but we are fearful of the absolute value of the European market for its domestic investors and wonder what the ‘clearing yield’ will be when the marginal euro comes back into the market, in a world with less central bank manipulation.

ECB head Mario Draghi has taken the market to sub-2% yield and any signs of reversal of this puppet mastery will surely lead to a sizeable drawdown. Who remembers the so-called taper tantrum when the US Federal Reserve opened the door to less stimulus back in 2013 (this led to a drawdown of around 5%, from a yield low on US$ BBs of 3.8%)?

 US BB yield versus Eur BB yield

Of course, as we sit in the summer of 2019, additional QE seems much more likely than less. Moreover, the leaders of the EU and, it seems, central bankers the world over, are obsessed with supernormal monetary policy being the solution to our economic and political problems (rather than, in fact, the problem). However, the theory of the greater fool, to us, is not a good reason to own European high yield when its yield barely covers inflation in the core countries of the EU.

With low yields and inferior spreads, we have been reducing our clients’ exposure to European high yield in our Global High Yield Fund. While everyone believes European high yield is bulletproof, we think this is a good time to be doing so. 

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Key Risks

Past performance is not a guide to future performance. Do remember that the value of an investment and the income generated from them can fall as well as rise and is not guaranteed, therefore, you may not get back the amount originally invested and potentially risk total loss of capital. The majority of the Liontrust Sustainable Future Funds have holdings which are denominated in currencies other than Sterling and may be affected by movements in exchange rates. Some of these funds invest in emerging markets which may involve a higher element of risk due to less well regulated markets and political and economic instability. Consequently the value of an investment may rise or fall in line with the exchange rates. Liontrust UK Ethical Fund, Liontrust SF European Growth Fund and Liontrust SF UK Growth Fund invest geographically in a narrow range and has a concentrated portfolio of securities, there is an increased risk of volatility which may result in frequent rises and falls in the Fund’s share price. Liontrust SF Managed Fund, Liontrust SF Corporate Bond Fund, Liontrust SF Cautious Managed Fund, Liontrust SF Defensive Managed Fund and Liontrust Monthly Income Bond Fund invest in bonds and other fixed-interest securities - fluctuations in interest rates are likely to affect the value of these financial instruments. If long-term interest rates rise, the value of your shares is likely to fall. If you need to access your money quickly it is possible that, in difficult market conditions, it could be hard to sell holdings in corporate bond funds. This is because there is low trading activity in the markets for many of the bonds held by these funds. Mentioned above five funds can also invest in derivatives. Derivatives are used to protect against currencies, credit and interests rates move or for investment purposes. There is a risk that losses could be made on derivative positions or that the counterparties could fail to complete on transactions.


The information and opinions provided should not be construed as advice for investment in any product or security mentioned, an offer to buy or sell units/shares of Funds mentioned, or a solicitation to purchase securities in any company or investment product. Always research your own investments and (if you are not a professional or a financial adviser) consult suitability with a regulated financial adviser before investing.

Monday, August 12, 2019, 1:43 PM