Investment bankers devoted hefty resources in 1997 and 1998 to promoting and gearing up for a European high-yield bond market. Following the Russian crisis, it collapsed. But proponents of European junk won’t let a catastrophic market crash deter them. They argue that plummeting values could be the market’s making. Spreads that have widened beyond all economic justification have finally made high yield sexy for the end-investor.
In a bulletin called “Every Cloud…?”, chief European bond strategist at Barclays Capital Gary Jenkins and colleagues observe that despite the hype accompanying the birth of European high-yield since early 1997, the region’s real investors generally stayed aloof. Bond issues relied on proprietary traders and the so-called backstop bid from the US. Europeans waited for proof that high-yield was here to stay – and for better bargains. Jenkins argues that “the sustainability of the market could not receive a more severe test than the worst economic turbulence since 1929”.
Jenkins advises European investors to spend early 1999 studying and scavenging. Thereafter, the market will begin to pick up as post-Emu investors seek high returns. And they are more likely to trust familiar, nearby firms such as mobile-phone provider Orange than those from developing countries with opaque financial practices. Though harmful in the short term, says Jenkins, “the current crisis may eventually act as a spur to the development of the European high-yield market”.
The market reopened: on October 26, UK cable company NTL, rated B/B3, launched a $625 million yankee-style issue paying 685 basis points over 10-year treasuries. There were bidders aplenty – but virtually all Americans, who were already familiar with NTL.
European investors are probing the secondary market, insist Merrill Lynch’s European high-yield researchers, who report “some buying of selected good-value bonds”. That particularly involves Orange and fellow telecoms company Colt.
Merrill’s head analyst Frank Knowles dismisses the thought that a collapsed market could have a lasting deterrent effect on Europeans. “High yield is no riskier than equity, yet no-one’s arguing that equity won’t bounce back.” But the difference is that liquidity doesn’t totally vanish in the stock market. And equity has long proven it can make more comebacks than the yo-yo.
Bankers in debt origination believe that European institutions, having underestimated and been stung by volatility, will stay at the liquid, quality end of the market. “Memories are going to be long this time”, says a banker who believes even demand for good credits will return only slowly.
A difference between the attitudes of UK and continental fund managers is evident. Martin Reeves, vice-president at Alliance Capital in London, is enthusiastic. “People are putting high yield, unfairly, in the same basket as emerging markets,” he says. “I believe it’s a great asset class.”
Like-minded continental investors do exist. Lorenzo Sisti is head of bond funds for Mediolanum Gestione Fondi in Milan. He finds European high yield “very interesting”, and points out that Italian investors will come under pressure from the downward trend of domestic bond spreads. Mediolanum will set up a dedicated fund for corporate Eurobonds rated triple-B to double-B. But he admits that a change of mentality will be needed before many other Italian buyers follow. “There is a cultural barrier at the moment. Investors know and like the big, established companies,” says Sisti. “Italian investors are quite scared of risk now. They have lost a lot of money, including in Russia and Latin America.”
But what repels many European investors most about high yield is its illiquidity. Jörg Herlan, a senior fund manager for Dresdner Bank’s mutual and pension funds, believes that buyers will take a while to rediscover credit bets, but they will remember still longer that illiquidity can sink an asset like a pair of cement boots. If they want yield, Herlan says, investors will go for investment-grade corporates or a few specific bonds at below investment grade.
Jean-Pierre Leoni, head of credit assets at AXA Investment Managers Paris, also limits his interest in high yield to the very best stories. “We’re very cautious on this market, because it can be very dangerous.” For French asset managers, thinks Leoni, high yield is likely to stay a small, supplementary asset.
Jenkins of Barclays Capital readily admits the difficulties facing the market. It is too illiquid because there aren’t enough end investors. Optimists argue the US backstop bid can make this market. But some US funds have already lost money this year by overestimating the depth and liquidity of Europe’s high-yield. They may continue to cherry-pick until they see more European money involved. Before this phoenix rises, it needs to overcome a chicken-and-egg problem. Marcus Walker
