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Capital Markets

Too quick to PIK? The deals set to haunt European high yield

Participants in the European high-yield market say the collapse of Phones 4U, which left PIK-note holders wiped out, was a one-off event. But it serves as a stark reminder of the liquidity trap that lies in wait for yield-hungry investors chasing each other further and further down the credit curve. And it calls into question whether European investors have developed the necessary credit skills to invest in such risky assets.

PIK

He must have had better Monday mornings. Many investors in European high yield had a nasty shock on September 1 when Phones 4U, the UK mobile phone retailer and high-yield bond issuer collapsed.

But the investment manager responsible for City Financial’s Credit Opportunities Fund must have needed an extra shot of coffee, or something stronger. His fund held 4.7% of the entire portfolio in the Phones 4U Payment-in-kind (PIK) note that had been issued the previous September. The day before the company collapsed, its senior secured notes had been yielding 9% and the PIK 15%. Within a matter of days the latter was worthless.

This shocking episode encapsulates the kind of risk that investors at the riskiest end of high yield are taking on in increasing numbers the longer zero interest rates persist. The long-overdue equity correction at the beginning of the third quarter combined with growing nervousness over anaemic economic growth prospects for Europe triggered a bout of the jitters in European high yield in early September.

By mid-October there had been more than $25 billion of outflows from European equities – a record $5.7 billion during the week of October 15 alone – and a lot of that money was heading straight back into the bond markets.


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