Risky Debt Seen as Safe Option in Europe as U.S. Rate Hike Looms

European bond investors are looking at riskier assets to guard against a potential interest-rate increase in the U.S.

“High-yield looks very attractive because its sensitivity to rate rises is limited,” said Louis Gargour, chief investment officer at LNG Capital, which has been shifting money to riskier assets from investment-grade debt for about six months. Investors should shun “zero-yielding government bonds because any increase in yields will be very painful,” said Gargour, who is speaking at a Euromoney corporate-debt conference in Paris on Thursday.

A Federal Reserve rate hike could spark a sell-off of investment-grade and sovereign debt in Europe as investors will have new alternatives to holding trillions of dollars of bonds yielding zero or less. Yields in Europe have tumbled because the European Central Bank has bought bonds in a bid to stimulate economic growth.

European junk bonds and leveraged loans may ride out an increase in U.S. rates because these products’ high yields will still be a lure for investors. Federal Reserve Chair Janet Yellen reiterated on Wednesday that most members of the policy-setting Federal Open Market Committee expect a rate increase will be needed this year. 

Investor Flexibility

“Investors must have the flexibility to invest on a global basis and across credit classes in order to deliver performance,” said Mitch Reznick, the London-based co-head of credit at Hermes Investment Management, which oversees about $35 billion. It’s difficult to outperform in investment-grade debt in Europe “because of the distortion in valuations due to central-bank buying,” said Reznick, who is also speaking at the Euromoney conference.

French drugmaker Sanofi and German household-products maker Henkel AG have both sold bonds in euros this month that yielded less than zero.

Investment-grade corporate debt in the single currency yields an average of 0.62 percent, close to the record low of 0.59 percent set earlier this month, according to Bloomberg Barclays index data. Yields on junk bonds are about 4 percent, the data shows.

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