EU CREDIT: Dig Below Headline Index In Search Of Relative Value

Look to sectors, not investment grade aggregates.

The corporate credit spread widening and the steeper quality curve trends witnessed across the global corporate credit space in recent months are now beginning to spark some debate within the investment community, as to whether current corporate bond valuation levels may offer compelling long-term value. Given the complex array of factors driving financial market sentiment today though, investors may now need to dig well below the broad investment grade and high yield credit indexes to find real relative value, Bloomberg strategist Simon Ballard writes.

The spread widening seen in corporate bonds over recent months has been driven by a combination of weak macroeconomic data and a cautious macroeconomic outlook, including China and global interest rate expectations. As a result, investment strategies based on aggregate investment grade and high-yield exposure may no longer work. Myriad drivers of risk asset sentiment and market pricing may suggest that focused cross-sector idiosyncratic analysis, incorporating careful consideration of issuer fundamentals may now be the preferred strategies for investors.

Breaking down investment grade and high yield indexes into their individual component sectors may offer relative value rewards. Taking the euro-denominated investment grade corporate bond index, rebased to 100 as of January 1, 2012, we note that the worst performing sectors in terms of yield spread widening have been the Materials and Energy sectors.

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Conversely, the sectors that have shown the most impressive spread outperformance have been Subordinated Financials, Industrials and Senior Financials. Other sectors that have also registered tighter spreads over the period include Technology, Utilities, Communications and Consumer Staples.

Meanwhile, in the euro-denominated sub-investment grade space, again rebased to 100 as of Jan. 1 2012, the Utilities and Industrials sectors have been the major spread underperformers, followed by Energy.

feb 4 Simon hy

The best spread performances have been seen in the Technology, Subordinated Financials and Consumer Staples sectors. These were followed by Communications, Healthcare, Subordinated Financials, Materials and Consumer Discretionary.

Analysis of these results may now be the most efficient way for investors to seek relative value opportunities at current spread levels. Within the context of the results shown, investors may look for value in moves such as the normalization between the outperformance in investment grade industrials and the underperformance of high yield industrials.

Note: Simon Ballard is a credit strategist who writes for Bloomberg. The observations he makes are his own and are not intended as investment advice.


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