Brexit Fallout Sends European Credit Investors Into Dollar Debt

  • U.S. corporate bonds offer higher returns than in Europe
  • Fund flows went into dollars, out of euros before referendum

Britain’s decision to exit the European Union is sending credit investors across the pond.

Dollar-denominated securities outperformed euro notes since the U.K. voted on Thursday to leave the 28-nation bloc, according to Bank of America Merrill Lynch index data. Goldman Sachs Group Inc. and CreditSights Inc. now recommend buying U.S. corporate bonds.

Investors are seeking refuge as they await Britain’s plan for its extrication from the EU, something that’s being held back by political upheaval in the country following the vote. Some are buying investment-grade bonds in euros on speculation that the European Central Bank will step up its bond purchase program, while others are looking further afield.

“The dollar credit market will almost certainly be seen as a safe haven now, even if it’s only temporary,” said Alex Eventon, a Paris-based fund manager at Oddo Meriten Asset Management which oversees 46 billion euros ($51 billion). “Contagion risks are on the minds of most investors.”

Fund Flows

Oddo Meriten increased dollar-denominated corporate bond holdings before the June 23 referendum, while cutting sterling exposure, Eventon said.

Retail investors favored dollar-denominated credit going into the vote. European investors placed $581 million into investment-grade credit funds in dollars in the week ended June 22, while they withdrew $310 million from sterling- and euro-funds, according to Bank of America Corp.’s analysis of EPFR Global data.

Increased political uncertainty in Europe will add to already strong global demand for dollar assets, including corporate bonds, CreditSights analysts wrote in a note. Goldman Sachs analysts changed their recommendation after the vote, saying investors should buy bonds in dollars instead of in euros because of better U.S. macro fundamentals.

Relative Returns

Investment-grade notes in dollars have returned 1.18 percent since Britons went to the polls, compared with 0.02 percent for bonds in euros, according to Bank of America Merrill Lynch index data. U.S. company bonds now yield an average 2.91 percent, compared with 0.96 percent for euro-denominated notes, the data show.

U.S. investment-grade bonds are the “destination of choice” for investors in Asia and Europe because they offer higher yield, said Andreas Michalitsianos, a global fixed-income portfolio manager at JPMorgan Asset Management, which oversees $1.5 trillion.

“It’s not a free lunch because of the cost to hedge the currency back to euro, yen or sterling, for example,” he said. “But we see very strong demand for investment-grade corporates right now in dollars.”

The Brexit vote also triggered a reversal in the relative cost of insuring U.S. and European corporate bonds.

Risk Reversal

A measure of credit risk in Europe has risen above that for the U.S., something that’s only happened a handful of times in the past two years. The Markit iTraxx Europe index insuring investment-grade bonds cost 89 basis points on Wednesday, compared with 85 basis points for the U.S. benchmark, according to data compiled by Bloomberg.

M&G Investments, a unit of U.K. insurer Prudential Plc, sold default protection on the Markit CDX North America High Yield Index on Friday as the outcome of the vote rippled through global markets.

“The U.S. economy should be less affected, if at all, by Brexit in comparison to the U.K. and Europe,” said Stefan Isaacs, a London-based fund manager at M&G Investments, which oversees more than 245 billion pounds ($328 billion) of assets. “Investors may look at the juicier yield in the U.S. and decide they don’t want the headache Europe is being engulfed in at the moment.”

    Before it's here, it's on the Bloomberg Terminal.