What about European corporate credit?
29 MAY, 2024
Author: Stanislas de Bailliencourt, Head of Fixed Income and Asset Allocation at Sycomore Asset Management, part of the Generali Investments ecosystem.
Despite resilient inflation pressures in the United States which could lead to a delay and fewer rate cuts by the Fed in 2024, with a rate normalization expected in Europe, rising oil prices and credit spreads at reasonable levels, we consider that the visibility remains fairly good for corporate credit as a whole after a year 2023 of sharp rises in interest rates. In a contrasting environment, our view is that the risk/return ratio remains favourable for European corporate bonds.
Credit spreads have begun to contract with the intrinsic improvement in corporate credit quality – as demonstrated by the many agency rating upgrades observed recently. The default rates on high-yield bonds have dropped to historical lows and may rise gradually in the foreseeable future. They could be mitigated by the following factors: good liquidity of issuers who benefited from a low rates environment to refinance their debt on longer durations and banks in better shape than in 2007 can support issuers.
Yields have returned to historically high levels, on High Yield segment notably. The high-yield bond market currently displays compelling technical characteristics. Indeed, the shrinking investment universe supports valuations, at a time when investors are clearly searching for yield. Furthermore, the dynamic primary market is likely to offer interesting investment opportunities.
Corporate financing risk seems to us rather limited today with a sound liquidity. Recent issuers have been plethoric on rather long duration, with credit lines usage not very high, and corporate debt repayment schedule have relative long duration. Moreover, issuers manage their balance sheet carefully, with more discipline towards M&A activity and capital expenditures.
Selectivity is key
Bond picking - very suitable to current market structure in our view - plays a major role in generating performance. The slowdown in growth is likely to impact the ratings of the European companies. We shall therefore focus on higher quality ratings.
Resilient companies are more able to resist to a more hostile economic environment. We therefore have a preference for moderately cyclical sectors, such as telecoms (Orange, TDC, T-Mobile Netherlands), utilities (Iberdrola, Veolia, Orsted), and companies capable of adjusting their investments to the cycle (Boels, Verisure, Loxam).
Also favour sectors driven by long-term and positive trends, such as infrastructure (Autostrade per l’Italia, Indigo). Or with high pricing power, including companies with recognised brands such as Birkenstock.
We prefer mid-dated bonds – between two years and five years maturity – and prefer quality intermediate credit, such as BBB and crossover BB ratings, which offer interesting value.
