Today, this market is worth nearly €400bn (£331bn) and its size has quadrupled since 2007. I do not believe this growth to be a cyclical blip. It won't reverse and this market will continue to grow.
The market's rapid growth is based on a structural change in how Europe is financing its corporates. Banks have been less willing to lend to European corporates since the financial crisis. More lending restraint is expected this year as the European Central Bank embarks on its asset quality review and stress tests. This is leading to a faster pace in the trend of financial disintermediation, where companies are sourcing their financing needs in the public markets rather than from traditional banking relationships.
Financial disintermediation is opening a whole new opportunity set to investors. Euro high yield's performance is driven by its own supply and demand characteristics that are separate to the US high yield market. We saw very clearly in the early summer of 2013 during the US tapering uncertainty. The US high yield market's performance disengaged from Europe as it tracked the US Treasury cycle and was pressured by investor outflows. In contrast, Europe's performance proved resilient.
Where are the opportunities?
One of the most striking trends over the last three years is the number of first-time issuers coming to market. This is an area of particular focus. 2013 was a record year for primary market issuance. More than one-third of that new supply originated from first-time issuers. In fact, a significant proportion of the market – around €100bn of bonds – is made up of companies that had not issued bonds before 2010.
This diversity is providing significant opportunities for differentiated security selection. I particularly like the growth that I am seeing in the single-B rated sector, as opposed to CCC-rated or BB-rated bonds. The single-B sector is the fastest growing area of the market. Researching lower-quality bond issuers takes more work; we have to dig in and work closely with those management teams to find the successful stories. But in a lower yield environment, an additional premium (the average yield-to-maturity of a B rated company exceeds 6%) can be captured for doing that hard work.
Macro and credit conditions remain supportive
Interest rates and inflation are likely to stay low in Europe over the medium term, in contrast to the Federal Reserve reducing market liquidity. Economic conditions in Europe remain supportive to corporate bond markets as the recovery remains tempered enough to restrain companies from engaging in risky re-leveraging practices.
Meanwhile, healthier economic conditions should improve corporate profitability, which should feed through to better balance sheet liquidity. Corporate credit fundamentals remain firm and the speculative global default rate remains well below its long-term average, and it is forecast to edge lower in 2014.
Euro high yield is a strategic, standalone asset class. In a more challenging fixed income market cycle, investors should not sit back and miss out on capturing opportunities to diversify and enhance performance in this dynamic and evolving marketplace.
Mike Della Vedova is manager of the T. Rowe Price European High Yield Bond Fund
