Incremental yield: The hidden value in European high yield

March 25, 2024

Standard spread metrics might suggest value is hard to find right now in European high yield. But investors should also pay attention to current bond prices, as Jamie Cane explains. 

European high-yield credit spreads have tightened since 2022.  At face value, spread-to-worst (STW) appears to be below the long-term average.

Yield-to-maturity versus yield-to-expected repayment

Market convention prompts investors look at ‘to worst’ spread and yield metrics.  When the cash price is below par, ‘to worst’ means to maturity. However, a key characteristic of high-yield bonds is their tendency to refinance around 1 to 2 years before maturity. This is what’s happening in the current environment, even though it might seem counterintuitive for corporates to refinance when interest rates are high.

Using the current average bond price of 94 as a starting point,¹ an investor expects to receive 6 additional points at maturity. This takes the price back to 100 (par). However, given the tendency of issuers to refinance before maturity, this 6-point discount is recouped over a shorter timeframe, resulting in a significant increase in yield and spread.

Case studies are for illustrative purposes only; they are not meant as a guarantee of any future results or experience and should not be interpreted as advice or a recommendation.

Figure 3 offers an example of this idea in action, involving a services company with an outstanding bond scheduled to mature in February 2027. The headline YTW is 4.7%. If the bond is repaid 1 to 2 years ahead of maturity, the yield to repayment is 5.4%-7.7%, a meaningful uplift. This bond is not atypical in the European high-yield market.

Hidden value

Overall, we believe this equates to an additional c.50 basis points over what is reflected in headline metrics. This takes European high-yield spreads back in line with their longer-term averages. In our view, this hidden convexity is a compelling feature of the asset class and something investors should consider favourably when assessing value.

References

1.ICE Data Platform, ICE BofA BB-B European Currency Non-Financial High Yield Constrained Index (HP4N) as of 29th February 2024.

 

This material is not intended to be relied upon as a forecast, research, or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed by Muzinich & Co are as of March 2024 and may change without notice.

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Index Descriptions

HP4N – The ICE BofA ML BB-B European Currency Non-Financial High Yield Constrained Index contains all non-financial securities in The ICE BofA ML European Currency High Yield Index rated BB1 through B3, based on an average of Moody's, S&P and Fitch, but caps issuer exposure at 3%.

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