Analysis  |  March 25, 2024

Incremental yield: The hidden value in European high yield

Standard spread metrics might suggest value is hard to find right now in European high yield. But investors should also pay attention to current bond prices, as Jamie Cane explains. 

European high-yield credit spreads have tightened since 2022.  At face value, spread-to-worst (STW) appears to be below the long-term average.

Yield-to-maturity versus yield-to-expected repayment

Market convention prompts investors look at ‘to worst’ spread and yield metrics.  When the cash price is below par, ‘to worst’ means to maturity. However, a key characteristic of high-yield bonds is their tendency to refinance around 1 to 2 years before maturity. This is what’s happening in the current environment, even though it might seem counterintuitive for corporates to refinance when interest rates are high.

Using the current average bond price of 94 as a starting point,1 an investor expects to receive 6 additional points at maturity. This takes the price back to 100 (par). However, given the tendency of issuers to refinance before maturity, this 6-point discount is recouped over a shorter timeframe, resulting in a significant increase in yield and spread.

Case studies are for illustrative purposes only; they are not meant as a guarantee of any future results or experience and should not be interpreted as advice or a recommendation.

Figure 3 offers an example of this idea in action, involving a services company with an outstanding bond scheduled to mature in February 2027. The headline YTW is 4.7%. If the bond is repaid 1 to 2 years ahead of maturity, the yield to repayment is 5.4%-7.7%, a meaningful uplift. This bond is not atypical in the European high-yield market.

Hidden value

Overall, we believe this equates to an additional c.50 basis points over what is reflected in headline metrics. This takes European high-yield spreads back in line with their longer-term averages. In our view, this hidden convexity is a compelling feature of the asset class and something investors should consider favourably when assessing value.

References

1.ICE Data Platform, ICE BofA BB-B European Currency Non-Financial High Yield Constrained Index (HP4N) as of 29th February 2024.

 

This material is not intended to be relied upon as a forecast, research, or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed by Muzinich & Co are as of March 2024 and may change without notice.

-----------------

Index Descriptions

HP4N – The ICE BofA ML BB-B European Currency Non-Financial High Yield Constrained Index contains all non-financial securities in The ICE BofA ML European Currency High Yield Index rated BB1 through B3, based on an average of Moody's, S&P and Fitch, but caps issuer exposure at 3%.

Important Information

Muzinich and/or Muzinich & Co. referenced herein is defined as Muzinich & Co., Inc. and its affiliates. Muzinich views and opinions.  This material has been produced for information purposes only and as such the views contained herein are not to be taken as investment advice. Opinions are as of date of publication and are subject to change without reference or notification to you. Past performance is not a reliable indicator of current or future results and should not be the sole factor of consideration when selecting a product or strategy. The value of investments and the income from them may fall as well as rise and is not guaranteed and investors may not get back the full amount invested. Rates of exchange may cause the value of investments to rise or fall. Emerging Markets may be more risky than more developed markets for a variety of reasons, including but not limited to, increased political, social and economic instability; heightened pricing volatility and reduced market liquidity.

Any research in this document has been obtained and may have been acted on by Muzinich for its own purpose. The results of such research are being made available for information purposes and no assurances are made as to their accuracy. Opinions and statements of financial market trends that are based on market conditions constitute our judgment and this judgment may prove to be wrong. The views and opinions expressed should not be construed as an offer to buy or sell or invitation to engage in any investment activity, they are for information purposes only.

This discussion material contains forward-looking statements, which give current expectations of a fund’s future activities and future performance. Any or all forward-looking statements in this material may turn out to be incorrect. They can be affected by inaccurate assumptions or by known or unknown risks and uncertainties. Although the assumptions underlying the forward-looking statements contained herein are believed to be reasonable, any of the assumptions could be inaccurate and, therefore, there can be no assurances that the forward-looking statements included in this discussion material will   prove to be accurate. In light of the significant uncertainties inherent in the forward-looking statements included herein, the inclusion of such information should not be regarded as a representation that the objectives and plans discussed herein will be achieved. Further, no person undertakes any obligation to revise such forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.

United States: This material is for Institutional Investor use only – not for retail distribution. Muzinich & Co., Inc. is a registered investment adviser with the Securities and Exchange Commission (SEC). Muzinich & Co., Inc.’s being a Registered Investment Adviser with the SEC in no way shall imply a certain level of skill or training or any authorization or approval by the SEC.

Issued in the European Union by Muzinich & Co. (Ireland) Limited, which is authorized and regulated by the Central Bank of Ireland. Registered in Ireland, Company Registration No. 307511. Registered address: 32 Molesworth Street, Dublin 2, D02 Y512, Ireland. Issued in Switzerland by Muzinich & Co. (Switzerland) AG. Registered in Switzerland No. CHE-389.422.108. Registered address: Tödistrasse 5, 8002 Zurich, Switzerland. Issued in Singapore and Hong Kong by Muzinich & Co. (Singapore) Pte. Limited, which is licensed and regulated by the Monetary Authority of Singapore. Registered in Singapore No. 201624477K. Registered address: 6 Battery Road, #26-05, Singapore, 049909. Issued in all other jurisdictions (excluding the U.S.) by Muzinich & Co. Limited. which is authorized and regulated by the Financial Conduct Authority. Registered in England and Wales No. 3852444. Registered address: 8 Hanover Street, London W1S 1YQ, United Kingdom. 2024-03-20-13188