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Now is the time to go global in credits

Now is the time to go global in credits

12-11-2020 | Insight

To meaningfully enhance the yield and total return on their fixed income portfolio, euro investors would need to look beyond the eurozone market.

  • Victor  Verberk
    Victor
    Verberk
    CIO Fixed Income and Sustainability
  • Reinout Schapers
    Reinout
    Schapers
    Director Emerging & Global Credit

Speed read

  • Euro bond investors face prospect of low and negative yields for longer 
  • Yield and return enhancement available for euro investors going global  
  • Active, global and unconstrained approach yields best results 

The great repression in euro bond yields

The economic fall-out from the Covid-19 pandemic and the subsequent unprecedented monetary support by the European Central Bank (ECB) has led to a dramatic compression of government and corporate bond yields in the eurozone. As a second wave of the virus sweeps across Europe, in turn prompting renewed (partial) lockdowns, expectations are that the great repression will continue, as the ECB will be keen to deliver further monetary easing. Fixed income investors in the eurozone therefore face the prospect of low and negative bond yields for longer.

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Figure 1 | Eurozone fixed income yields

Source: Robeco, Bloomberg. Data end of September 2020.
In this yield-scarce context, investors could increase the yield and total return on their euro bond portfolio by allocating to corporate bonds, but this might not be sufficient to meet their yield and return targets. To meaningfully enhance the yield and total return on their fixed income portfolio, euro investors would need to look beyond the eurozone fixed income market.

Return enhancement by going global

Investors who are currently invested primarily in a euro credit portfolio could consider a global credit allocation to enhance their portfolio return. There are two important reasons for this. 

Firstly, by shifting to a global credit portfolio, euro investors are able to generate a higher EUR-hedged yield. This can be illustrated by the yield pick-up when comparing European credit indices with global strategies. For example, as at the end of October 2020, Robeco Global Credits offers a EUR-hedged yield of 1.6% compared to the 0.4% yield on the Bloomberg Barclays Euro Corporate Index. Robeco Global Credits – Short Maturity offers a EUR-hedged yield of 0.7% compared to the 0.2% yield on the Bloomberg Barclays Euro Corporate 1-5 year index.

Figure 2 | Yield euro vs. global credit portfolios

Source: Robeco, Bloomberg. Data end of October 2020.

Secondly, a global credit allocation greatly enhances the opportunity investors have to enhance the total return on their fixed income portfolio.

The EUR-denominated investment grade corporate universe consists of approximately 600 companies, with an estimated 3,000 bonds. If we include other currencies (mainly USD and GBP), the universe expands to 1,900 companies with 13,000 bonds. Including emerging market and high yield corporates would expand the investment universe even further. 

An unconstrained, global approach yields best results

To truly benefit from the valuation opportunities in global credit markets, an active, flexible and unconstrained strategy would yield the best results. 

One reason for this is that some sectors or segments of the market are better represented in one region than another. For example, the number of energy companies in the global universe is significantly higher than in the euro corporate index and is also more diverse, allowing investors to have exposure to a better spread of energy companies. We have seen a number of interesting value opportunities in the energy sector this year. These opportunities have been in European oil majors as well as in high-quality US midstream energy companies like gas pipeline operators, that have well-regulated and stable businesses. 

Another example of the larger investment opportunity available when investing outside the Eurozone are the opportunities in longer-dated credit. The market for longer-dated corporate debt (bonds with 10-year+ maturities) is much larger and more diverse in the US compared to the Eurozone. For example, after the market sell-off in March, we saw many high-quality investment grade companies in the US issuing longer-dated bonds at very attractive spread levels and new issuance premia. These bonds performed very well in the market rebound in the second and third quarter of this year.

A global approach to investing in credit markets also allows investors to benefit from the relative value opportunities between corporate bonds denominated in different currencies. We often see differences in spread levels on a EUR-hedged basis between bonds issued in different currencies by the same company and with similar maturities. Due to differences in trading conventions or unfamiliarity with the issuer, significant credit spread differences can arise, even between bonds from the same issuer. A global approach can capture these relative value opportunities.

Investors whose mandates permit them to invest in hard-currency emerging market corporates have access to even more opportunities to find value in global credit markets.  

Very often, the economic cycle in emerging markets is completely disconnected from the European or US economy, which could create value opportunities. We prefer to invest in large well-diversified, well-run companies that increasingly generate their revenues outside of their home market. 

Further, having the flexibility to invest in the cross-over segment between high yield and investment grade can also significantly contribute to returns. The opportunity here is sizeable. More than half of the US credit market consists of BBB-rated issuers and, over the year to date, we have seen more than USD 150 billion in US investment grade debt downgraded to high yield. Although bonds of downgraded companies may experience severe price pressure, they potentially could recover sharply once they are incorporated in the high yield index. This can be an important source of alpha for an active and unconstrained global credit strategy that invests in the cross-over segment.

Robeco has a long history in global credit investing and we offer various global credit funds to benefit from the opportunities in global credit markets (see Figure 3). 

Figure 3 | Robeco’s Global Credit fund range

Source: Robeco. The above-mentioned limits are internal guidelines. The limits mentioned in the prospectus are leading.
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