Date: September 6, 2018
A Rare U.S.-Europe Junk Bond Split Tantalizes Big-Money Funds
Europe’s high-yield bond market has gotten tantalizingly cheap, according to big-gun debt funds. Money managers at JPMorgan Asset Management and PGIM Inc. who oversee about $70 billion collectively say it’s time to buy. Even as Italy’s populist government bids to balloon the deficit, the supply season looms and emerging-market contagion fears, the market has a valuation buffer, say investors. Case in point: Europe’s speculative-grade companies are trading with higher spreads than U.S. peers, driven in part by populists in Rome rising to power in May. That’s a break from historic norms given the region’s typically higher average ratings. It’s an anomaly that “jumps out” at Michael Collins, a senior portfolio manager at PGIM. “We’ve actually looked at that relative-value differential, so we’re on the margin buying European high yield relative to U.S. high yield,” Collins said in an interview with Bloomberg TV last week. “You’ve seen repricing in euro credit purely on perception of political risk rather than fundamentals,” said Greg Venizelos, a senior credit strategist in London at AXA Investment. “There’s been a typical kind of contagion effect from Italy to different classes of credit in Europe.” The withdrawal of European Central Bank quantitative easing is a wild card. If it pushes yields higher, companies with heavy refinancing needs would be squeezed. Meanwhile, ‘tourist’ investors who piled into high-yield bonds may return to their safety zones in the investment-grade space, withdrawing cash. Tatjana Greil Castro, a portfolio manager at Muzinich & Co., says she expects euro-area bonds to get cheaper still. “The high-yield market has already seen a reprice with as much as a 100 basis points widening so far this year,” Greil Castro said at a conference in London this week. “But with just around a 3 percent yield for the asset class on the whole, the expectation of inflows is minimal, which could see spreads widen further still.” Flows show a flight out of European-focused high-yield bond funds in the last week of August — even as those with a global and U.S. bent attract cash, according to EPFR flow data.
Europe’s Volatile Flank Finds Itself Focus of Global Attention
If history is anything to go by, Europe’s most volatile region is headed into another precarious period, and the repercussions could again be felt around the world. Serbia and Kosovo are seeking to mend ties after years of failed efforts and animosity stemming from the Yugoslav wars and their ultimate split a decade ago as the Kosovars declared independence. A key component of a proposed deal involves swapping chunks of territory to allow people of the same ethnicity to live together. Yet as Serb President Aleksandar Vucic and his Kosovar counterpart, Hashim Thaci, prepare for talks in Brussels on Friday, the very notion of the land deal is causing diplomatic tremors from Moscow to Washington, Berlin and Beijing. Where some claim to see an opportunity for permanent peace, others regard the proposal of swapping territory as an unacceptable risk to take in the Balkan region, where Europe’s bloodiest conflict since World War II raged on and off throughout the 1990s. The proposal, which is seen to be gaining ground, has also sent shock waves throughout former Yugoslavia. While some countries in the region have progressed and joined the European Union and NATO, Serbia, Kosovo and Bosnia remain in vulnerable limbo as world powers jostle for influence and nationalist forces advance across the continent. German Chancellor Angela Merkel, who is alert to any hint of stoking instability on Europe’s southeastern flank, has rejected redrawing borders. The foreign ministry in Berlin believes it would set a damaging precedent for other fragile regions divided along ethnic lines, including Bosnia and the Republic of Macedonia, which Merkel is due to visit on Saturday. Michael Roth, Germany’s minister for Europe, said this week “such a move would open a Pandora’s box of ethnic recriminations.”
Italian Banks’ Outlook Cut by Fitch Amid Political Concerns
UniCredit SpA and Intesa Sanpaolo SpA were among five Italian banks that Fitch Ratings said could have their credit ratings cut along with that of the state, should the nation’s populist government relax its predecessor’s fiscal discipline. Mediobanca SpA, Credito Emiliano SpA and Banca Nazionale del Lavoro SpA were also given a negative outlook, down from stable, Fitch said Wednesday as it confirmed the five banks’ long- and short-term ratings for now. Fitch cut its outlook on Italy to negative on Friday. The decision reflects Fitch’s view that the banks would likely be downgraded if Italy’s rating was cut, given their exposure to the domestic economy and their purchases of government debt. Last week, Fitch said there was an increased chance that Italy’s government will reverse some previous structural reforms, negatively impacting the country’s credit fundamentals. It also said the relatively high degree of political uncertainty compounds the risk. This summer, investors have turned their attention to Italy’s budget, sending bond yields higher in response to the new government’s expensive electoral promises. Those pledges include hefty tax cuts and some form of universal income for the poor that could have a negative impact on the country’s debt and deficit. There is a “strong link between sovereigns and banks’ ratings,” Andrea Filtri, an analyst at Mediobanca, wrote in a note Thursday. Still, the Italian government is making “more market-friendly statements of fiscal discipline” of late, Mediobanca’s Filtri said. While the banks’ shares were little changed, Wednesday, they have underperformed the national stock benchmark this year, with UniCredit and Intesa both down about 15 percent. While UniCredit is more geographically diversified than the other four banks, its risk profile remains highly correlated with that of Italy, Fitch said.
Asia Embraces Dual-Class Shares, and Investor Activists Smolder
In the battle between Asia and the U.S. for the next wave of technology listings, the shareholder advocates lost out. After years of debate, Hong Kong and Singapore’s stock exchanges this year allowed companies to list shares with different voting rights. The fear that the next Alibaba Group Holding Ltd. or Baidu Inc. would opt for New York finally won out over concerns that dual-class shares would erode the long-term integrity of markets by allowing corporate founders to run roughshod over other investors. Xiaomi Corp. illustrates why. The Chinese smartphone maker raised $5.4 billion in an initial public offering in Hong Kong in July, shortly after the new rules took effect. It is now one of the most actively traded stocks on the exchange and its second-largest tech company by market value. And a raft of other tech issuers are waiting in the wings, including restaurant review and delivery giant Meituan Dianping. It’s “the dawn of an exciting new era,” Hong Kong Exchanges & Clearing Ltd. Chief Executive Officer Charles Li said in April when announcing the adoption of dual-class shares. While opponents to dual-class shares like Aberdeen Standard Investments are sticking to their guns, the rising clout of tech companies — whether they use such structures or not — underscores why there’s no turning back for Asian exchanges. Apple Inc. is now the world’s only $1 trillion market value company, and tech companies occupy the top five spots by that measure. Alibaba and Tencent Holdings Ltd., China’s most famed internet success stories, are also its most valuable companies. “It looks like dual-class shares are here for now,” said David Smith, Asia head of corporate governance at Aberdeen. “We need to be careful, though, that investor protection is balanced with this commercial desire to attract listings.” Dual-class shares are nothing new, and they’ve long been a favored option among tech founders who say the setup allows them to make strategic decisions that may be unpopular among investors focused on the vagaries of quarterly earnings. As Google parent Alphabet Inc. and Facebook Inc. rose to global dominance, Chinese founders took note. Hong Kong changed its rules in April to allow dual-class listings, while Singapore approved them in June. China is finalizing rules for so-called Chinese depository receipts, a new type of security that will allow dual-class structures, to keep up in the race for tech listings.