Taking Long View in Europe Pays With 14% Returns: Credit MarketsJohn Glover
European corporate bonds maturing in a decade or more are outperforming similar securities in the U.S. for a third month as feeble growth and falling consumer prices prove a boon for borrowers.
Investment-grade bonds in euros due in 10 years or more returned 14.4 percent this year, assuming reinvested interest, compared with 13 percent in the U.S., according to Bank of America Merrill Lynch index data. Returns of 1.76 percent in Europe this month, against 0.9 percent in the U.S., makes this the longest period of outperformance in a year.
Companies are capitalizing on the rally to push out debt maturities and lower borrowing costs. They’ve raised an average 23.3 billion ($31 billion) a month selling bonds maturing in a decade or more this year, compared with 16.8 billion euros a month in 2013, according to data compiled by Bloomberg.
“Bad economic data is good for bonds,” said Ben Bennett, a London-based credit strategist at Legal & General Investment Management Ltd., which oversees the equivalent of about $120 billion of corporate bonds. “We have low growth, low inflation and little investment and that means looser monetary policy for longer.” Bennett said he prefers German bunds to corporate credit.
The euro area’s recovery stalled in the second quarter as its three biggest economies -- Germany, France and Italy -- failed to grow. Inflation slowed to 0.4 percent in July, less than the European Central Bank’s goal of just under 2 percent, with the risk of deflation taking hold in Spain and Portugal.
Record-low central bank interest rates are holding down short-term borrowing costs, forcing bond investors to buy longer-dated securities or debt from lower-rated issuers as they search for returns.
Aeroports de Paris, manager of that city’s airports, issued 2.75 percent bonds due in 15 years in May 2013 at a price of 98.84 cents on the euro. The notes are now at 107 cents to yield 2.13 percent, data compiled by Bloomberg show.
Bonds due July 2039 issued by Energie Baden-Wuerttemberg AG, Germany’s third-largest electricity supplier, at 98.51 cents on the euro are quoted at 153 cents to yield 3.03 percent, Bloomberg data show. The notes, which were issued in July 2009, returned 33 percent this year.
Gains in Europe have been led this year by financials, such as Italy’s biggest insurer Assicuarzioni Generali SpA, which have handed investors more than 17 percent. Telecommunications companies returned more than 15 percent, according to Bank of America Merrill Lynch indexes.
The rally is being underpinned by the greatest returns on long-dated government bonds in 16 years, according to Bank of America Merrill Lynch index data. European government bonds returned 18.4 percent, compared with 1.58 percent for all of last year. The extra yield investors demand for corporate bonds rather than similar government debt fell to 1.14 percentage points from 1.20 percentage points at the start of the year.
Money managers didn’t forecast it to be this way. Yields on 10-year European government bonds, the benchmark for long-term corporate bonds, opened the year at 1.9 percent and Treasuries were at about 3 percent. Investors including Bill Gross at Pacific Investment Management Co. and James Keenan, managing director at BlackRock Inc., advised investors to focus on shorter-term securities as the economy recovered and the Federal Reserve withdrew stimulus.
Yields on 10-year government notes have since dropped and are now at about 1 percent in Germany and 2.40 percent in the U.S.
Long-dated corporate bond yields in Europe have followed a similar pattern, falling to a record 2.52 percent after starting the year at 3.49 percent.
“This is typically the moment when credit does well, so investors are content to take on risk,” said Andrea Cicione, a strategist at Lombard Street Research Ltd. in London, who recommends investors hold corporate credit and long-dated debt. “However, the trade is becoming crowded and that’s dangerous because all you need is a change in sentiment and you underperform.”
Investors aren’t expecting benchmark rates in Europe to change any time soon, money-market instruments show. A contract expiring in June that signals the expected cost of overnight borrowing in euros at that date is at 0.0015 percent, according to data compiled by Bloomberg.
“Everything is predicated on easy central bank money,” said Marc Ostwald, a strategist at brokers ADM Investor Services International Ltd. in London. “You can’t sit on cash or you will underperform. You have to join the herd or get decapitated.”