Erste Asset Management

High-yield bonds – a look behind the scenes

High-yield bonds – a look behind the scenes
High-yield bonds – a look behind the scenes
(c) iStock
Share post:
Author: Christin Bahr, Product Management Securities Erste Group

In the context of record lows of money market rates and low government bond yields, high-yield bonds remain in demand. In view of the already very low spreads it may be worthwhile having a closer look at this bond segment.

Ratings – what do they tell us?

 

Corporate bonds are rated by rating agencies such as Standard & Poors or Moody’s. The scale of rating classes ranges from AAA/Aaa (excellent) to D (default). High-yield bonds are bonds with ratings of BB, B, CCC, CC, and C. The investor assumes a higher default risk when investing in these bonds, but he/she receives a higher coupon/yield in return. Hence the term “high-yield bond”.

The historical default rates differ very much from each other, depending on the rating. For example, 15.1% of B-rated euro corporate bonds in the market index1 have defaulted in the past five years2, whereas only 5.7% of BB-rated bonds have defaulted.

1 BofAML Euro High Yield Index, as of 14 December 2017
2 Sources: ERSTE SPARINVEST on the basis of Deutsche Bank, S&P, Markit Group, default rates from each respective monetary union, cumulated over five years. As of 19 April 2017.

At the moment, the average annual yield to maturity of ESPA BOND EUROPE HIGH YIELD is  2.93%, and it is 6.48% for ESPA BOND USA HIGH YIELD.* Although at this point one has to deduct about 2% in costs for permanent hedging of the US dollar vis-à-vis the euro for ESPA BOND USA HIGH YIELD, this segment is still more attractive than its European peer.

*Data as of 29 December 2017. Source: Erste Asset Management

Europe: stronger ratings, higher weighting of the financial sector

The USD yield is currently beating its EUR counterpart; which is normal, since interest rates are higher in the US dollar region. But there is another reason for this difference, because the structure of the two high-yield markets bears significant differences. For example, the average rating of EUR high-yield bonds is BB, whereas that of USD high-yield bonds is only B. The average rating quality of USD high-yield bonds is also below that of their EUR peers. This is due to the sector allocation. In Europe, banks, telecoms, and utilities dominate the bond market, whereas in the USA the – in qualitative terms – weaker energy sector, industrials, and commodities play an important role.

What is the status quo?

Both in Europe and the USA, the economic upswing is intact. Profit margins have improved sustainably in particular among US companies, the most recent key balance sheet ratios are stable, and the levels of liquidity are sufficient3. According to IMF experts, the recently passed tax reform comes with a stimulating effect on the USA and its trading partners, at least temporarily.
3 Source: Erste Group Research, Global Strategy, January 2018

Default rates are at historically low levels, and the forecast by Moody’s dips even lower for the end of 2018.4
4Source: Moody’s Monthly Default Update: Global Corporate Default and Recovery Rates, as of November 2017

 

Historic annual default rates. Source: Moody’s Monthly Default Update: Global Corporate Default and Recovery Rates, as of November 2017

Diversification is key

By buying a high-yield bond, the investor assumes the default risk of an individual issuer. Spreading one’s capital across a larger number of companies is important in order to avoid cluster risks. At the moment, ESPA BOND USA HIGH YIELD contains 456 bonds, and ESPA BOND EUROPE HIGH YIELD holds 168 bonds. This means that the funds offer a broad degree of diversification also for small investment sums. The risk is spread across many issuers, and the attractive coupons are reflected in the regular dividends distributed by the funds.

High-yield bonds: pros and cons

Opportunities
  • Broad diversification across high-yield bonds
  • Sustainably attractive investment segment
  • Chance of high annual dividends
  • Currency hedging, therefore no currency effects
Risks
  • The share price of the fund may be subject to significant fluctuations
  • Price declines are possible particularly in the event of widening spreads (i.e. worsening ratings)
  • Average to low rating outside the investment grade segment, i.e. elevated risk of default
  • Capital loss is possible
Legal note:

Prognoses are no reliable indicator for future performance.

RESPOND TO THE ARTICLE

Legal disclaimer

This document is an advertisement. Unless indicated otherwise, source: Erste Asset Management GmbH. The language of communication of the sales offices is German and the languages of communication of the Management Company also include English.

The prospectus for UCITS funds (including any amendments) is prepared and published in accordance with the provisions of the InvFG 2011 as amended. Information for Investors pursuant to § 21 AIFMG is prepared for the alternative investment funds (AIF) administered by Erste Asset Management GmbH pursuant to the provisions of the AIFMG in conjunction with the InvFG 2011.

The currently valid versions of the prospectus, the Information for Investors pursuant to § 21 AIFMG, and the key information document can be found on the website www.erste-am.com under “Mandatory publications” and can be obtained free of charge by interested investors at the offices of the Management Company and at the offices of the depositary bank. The exact date of the most recent publication of the prospectus, the languages in which the key information document is available, and any other locations where the documents can be obtained are indicated on the website www.erste-am.com. A summary of the investor rights is available in German and English on the website www.erste-am.com/investor-rights and can also be obtained from the Management Company.

The Management Company can decide to suspend the provisions it has taken for the sale of unit certificates in other countries in accordance with the regulatory requirements.

Note: You are about to purchase a product that may be difficult to understand. We recommend that you read the indicated fund documents before making an investment decision. In addition to the locations listed above, you can obtain these documents free of charge at the offices of the referring Sparkassen bank and the offices of Erste Bank der oesterreichischen Sparkassen AG. You can also access these documents electronically at www.erste-am.com.

N.B.: The performance scenarios listed in the key information document are based on a calculation method that is specified in an EU regulation. The future market development cannot be accurately predicted. The depicted performance scenarios merely present potential earnings, but are based on the earnings in the recent past. The actual earnings may be lower than indicated. Our analyses and conclusions are general in nature and do not take into account the individual characteristics of our investors in terms of earnings, taxation, experience and knowledge, investment objective, financial position, capacity for loss, and risk tolerance.

Please note: Past performance is not a reliable indicator of the future performance of a fund. Investments in securities entail risks in addition to the opportunities presented here. The value of units and their earnings can rise and fall. Changes in exchange rates can also have a positive or negative effect on the value of an investment. For this reason, you may receive less than your originally invested amount when you redeem your units. Persons who are interested in purchasing units in investment funds are advised to read the current fund prospectus(es) and the Information for Investors pursuant to § 21 AIFMG, especially the risk notices they contain, before making an investment decision. If the fund currency is different than the investor’s home currency, changes in the relevant exchange rate can positively or negatively influence the value of the investment and the amount of the costs associated with the fund in the home currency.

We are not permitted to directly or indirectly offer, sell, transfer, or deliver this financial product to natural or legal persons whose place of residence or domicile is located in a country where this is legally prohibited. In this case, we may not provide any product information, either.

Please consult the corresponding information in the fund prospectus and the Information for Investors pursuant to § 21 AIFMG for restrictions on the sale of the fund to American or Russian citizens.

It is expressly noted that this communication does not provide any investment recommendations, but only expresses our current market assessment. Thus, this communication is not a substitute for investment advice, does not take into account the legal regulations aimed at promoting the independence of financial analyses, and is not subject to a prohibition on trading following the distribution of financial analyses.

This document does not represent a sales activity of the Management Company and therefore may not be construed as an offer for the purchase or sale of financial or investment instruments.

Erste Asset Management GmbH is affiliated with the referring Sparkassen banks and Erste Bank.

Please also read the “Information about us and our securities services” published by your bank.

Subject to misprints and errors.