Global High Yield Perspectives

Transcription

1 Topical Insight June 3, 215 Global High Yield Perspectives 3Q 215 Magnum vectigal est parsimonia (Translation: Thrift is a great revenue ) Cicero "The realistic proposal from Greece will have to be matched by an equally realistic proposal on debt sustainability from the creditors. Only then will we have a win-win situation. Otherwise, we will continue the lethargic dance we have been dancing for the past five months. As a final comment I want to stress that offering help to Greece, especially in the context of debt, cannot be a justification of the wrong economic philosophy, which is the main source of the crisis. And so, I believe that that Europe s assistance for Greece should be accompanied by an old Roman saying 'Magnum vectigal est parsimonia.'" Donald Tusk, President of the European Council Donald Tusk, President of the European Council, repeated Cicero s quotation in public comments during the recent, heated bailout negotiations with Greece. He hoped Greece would take these words to heart; fortunately they did. The high yield asset class, which since the 28 global financial crisis has certainly taken these words to heart, continues to offer very attractive absolute and risk-adjusted returns. In a quarter punctuated by rises in inflation expectations and safe-haven yields, slowing Chinese growth, depreciating emerging currencies, deteriorating oil prices, and real concerns over Greece s place in the euro zone, the high yield asset class continues to outperform (see Figure 1 below). Gerhardt (Gary) Herbert, CFA Brian L. Kloss, JD, CPA Regina G. Borromeo* Figure 1 Asset Class Total Returns (%); As of July 13, 215 Loans HY Corp S&P Tracy Chen, CFA, CAIA Sr. Research Analyst PM Mortgage Backed Securities ABS Agencies MBS Treasuries Aggregate IG Group -5. (1.).8 (.32) (.38) Source: Morgan Stanley, S&P LCD, the Yield Book, Bloomberg * Employee of Brandywine Global Investment Management (Europe) Limited. In rendering portfolio management services, Brandywine Global Investment Management, LLC may use the portfolio management services, research, and other resources of its affiliates. For Institutional Investors Only

2 Global High Yield Perspectives - 3Q 215 p2 Topical Insight June 3, 215 Returns for the asset class continue to be positive and volatility has been subdued given elevated macro economic risk factors, especially with a Federal Reserve rate hike on the horizon. In our view, the real issue for the next several quarters is which asset class is correctly anticipating or better said, pricing in the challenges facing the global economy. Fundamentals in the high yield asset class continue to be attractive. Whether we consider return on equity (see Figure 2 below) or attachment points (e.g leverage, Figure 3 below), the high yield bond asset class has not seen a material deterioration in leverage or returns on equity. Quite the contrary, the asset class has been a bastion of stability, especially when one excludes energy-related credits. Figure 2 Proportion of US HY Firms (ex. Energy) with ROE <5% Has Been Declining US HY (ex. Energy) Distribution of ROE of CDX HY Companies, % of companies; As of March 31, < Source: RBS Credit Strategy,Bloomberg. Figure 3 US HY (ex. Energy) Companies Have Reduced Their Leverage Over The Last Quarters US HY (ex. Energy): Distribution of Net Debt/EBITDA of itraxx Xover Companies, % Companies; As of March 31, < -1x 1-2x 2-3x 3-4x 4-5x 5-6x >6x Source: RBS Credit Strategy,Bloomberg.

3 Global High Yield Perspectives - 3Q 215 p3 Topical Insight June 3, 215 Even relative to leveraged loans, high yield bonds look superior in terms of leverage (see Figure 4). Increasing leverage and deteriorating covenant quality have been a hallmark of the leveraged loan market the last several quarters. Leverage now stands at north of five times earnings before interest, taxes, depreciation, and amortization, (see Figure 4). Most of the proceeds of issuance are now being used for leveraged buyouts (LBOs), dividends or buybacks, and acquisitions (see Figure 5), while investors are demanding little in the way of covenant protections (see Figure 6). Figure 4 Leveraged Loan Fundamentals Gross Leverage; As of June 3, x 5.x 4.5x 4.x 3.5x 3.x 5.14x Figure 5 Leveraged Loan Use of Proceeds; As of July 15, 215 1% 8% 6% 4% 2% 2.5x % Source: Morgan Stanley Research, Bloomberg LBO Refinancing Acquisition Dividend/Buyback Other Figure 6 New Issue First-Lien Cov-Lite Loan Volume ($Bn); As of July 15, % Figure 7 Markets Underestimating The Progress Made In Europe Difference In Ranking Between Germany and the Periphery in the World Bank s Survey of How Easy or Difficult it is to Do Business in Different Countries; As of July 15, % 2 Greece Portugal Spain Italy Ireland 15 4% 1 5 2% -2-4 % Volume Percent

4 Global High Yield Perspectives - 3Q 215 p4 Topical Insight June 3, 215 Of particular concern for a high yield investor who considers opportunities globally are the political challenges in Europe as its respective economies adjust, and the continuing decline in emerging market currencies. First, we believe competitiveness is improving in Europe. Investors allocated to this region may be rewarded in coming quarters as the gap between the periphery and Germany in terms of competitiveness improves, even with Greece s challenges (see Figure 7 on previous page). Improved competitiveness is supporting capital formation and real domestic demand growth, both very positive signals that emphasize the efficacy of the European Central Bank s (ECB s) unorthodox monetary policy, although belatedly (see Figures 8 and 9). Figure 8 July s Strong BLS Should Support EA Domestic Demand As of July 15, % 4.% 2.%.% -2.% -4.% -6.% -8.% -1.% -12.% Figure 9 Business Demand For Loans For Fixed Investment Purposes Is A Positive Signal For Investment As of July 15, % 2. 1% 1.. 5% -1. % % % % % % Real Domestic Demand Growth (% q/q ar) Bank Lending Survey: Supply/Demand Indicator BLS 3M Chng In Business Demand for Loans (Fixed Investment) EA Chng In Gross Fixed Capital Formation (%q/q AR) Source: Deutsche Bank, ECB Source: Deutsche Bank, ECB Figure 1 The Eurozone s Morosani Index Indicates A Pick-up In Inflation Eurozone Morosani Index, 6m Smoothed, 12m Lagged & Eurozone Core CPI, 6m Smoothed Morosani Index = Capacity Utilization/Broad Trade Weighted Euro Index Figure 11 Emerging Market Corporate Sector Leverage Debt to EBITDA, Times; As of June 2, Gross Net Morosani Index (RHS) Core CPI (LHS) Source: Gavekal Data/Macrobond Source: IIF As the ECB continues to grow its balance sheet, we believe inflation will rise. In fact, leading indicators indicate an inflation increase is a strong likelihood (see Figure 1). Should this leading indicator be accurate, European high yield and low-quality European residential mortgage-backed securities have the potential to provide attractive returns. While Europe is a story of improvement, emerging markets have been a tale of woe, especially in local currency terms. Declining productivity, enormous currency volatility, and increasing leverage have led to a challenging outlook. Leverage continues to rise in the emerging market corporate sector, having essentially doubled in the last five years (see Figure 11). With lower commodity prices, we anticipate leverage will continue to stay elevated in the coming quarters.

5 Global High Yield Perspectives - 3Q 215 p4 Topical Insight June 3, 215 Our concern is that the currencies have borne the brunt of adjustment while emerging market sovereign and credit spreads have not yet recognized the declining productivity and increasing leverage. A small sampling of emerging market and commodity-dependent currencies highlights the magnitude of changes (see Figure 12); this volatility is also embedded in the currencies of the G2 economies, and is approaching Lehman and potentially may reach Asian crisis levels (see Figure 13). Figure 12 Exchange Rate Changes vs. US Dollar on 2 June 215 (%) 3 Figure 13 GDP-Weighted Ranged-Based FX Volatility (Rolling 52 Weeks) For the Largest 2 Countries in the World; As of June 19, Asian and Russian Financial Crisis -3 2 Lehman Since End-213 Since End CNY JPY INR AUD KRW IDR TWD Source: Bloomberg Source: BofA Merril Lynch Global Research Emerging market sovereign and credit spreads have been especially nonplussed by these factors (see Figure 14). We take these deteriorating macro factors in emerging economies very seriously and expect to have limited exposure in these markets until prices reflect the actual underlying risk. While the U.S. economy continues its path toward moderate economic growth, Europe continues to grapple with the challenges of improving sovereign competitiveness in an inflexible currency union and emerging markets face the challenges of depressed commodity prices. Despite the international factors, the Federal Reserve is intent on tightening monetary policy. Given these factors, we continue to improve quality in our portfolios, 2 reduce credit duration, maintain higher-than-normal cash balances, and limit our emerging market exposures. 15 Aug 13 Nov 13 Feb 14 May 14 Aug 14 Nov 14 Feb 15 May 15 The views expressed represent the opinions of Brandywine Global Investment Management, LLC and are not intended as a forecast or guarantee of future results. All Source: Bloomberg, Morgan Stanley Research information obtained from sources believed to be accurate and reliable. Fixed income securities are subject to credit risk and interest-rate risk. High yield, lower-rated, fixed income securities involve greater risk than investment-grade fixed income securities. There may be additional risks associated with international investments. International securities may be subject to market/currency fluctuations, investment risks, and other risks involving foreign economic, political, monetary, taxation, auditing and/or legal factors. These risks may be magnified in emerging markets. International investing may not be suitable for everyone. Brandywine Global believes that transactions in any option, future, commodity, or other derivative product are not suitable for all persons, and that accordingly, investors should be aware of the risks involved in trading such instruments. There may be significant risks which should be considered prior to investing. Derivatives transactions may increase liquidity risk and introduce other significant risk factors of a complex character. All securities trading, whether in stocks, options or other investment vehicles, is speculative in nature and involves substantial risk of loss. Characteristics, holdings and sector weightings are subject to change and should not be considered as investment recommendations. Indices are unmanaged and not available for direct investment. All data current as of the date at the top of the page unless otherwise noted. This information should not be considered a solicitation or an offer to provide any Brandywine Global service in any jurisdiction where it would be unlawful to do so under the laws of that jurisdiction. Past performance is no guarantee of future results. 215,. All rights reserved. Figure 14 Adjusting for HY, Spreads Are Not Particularly Wide EMBIG Spreads (bp); As of July 15, EM Credit Index Index Ex-RUS, UKR, VEN, ARG Difference (RHS)