Download Sterling corporate bonds: an investor`s guide

December 17 2014
Sterling corporate bonds:
an investor’s guide
VALENTINE AINOUZ, Strategy and Economic Research – Paris
SERGIO BERTONCINI, Strategy and Economic Research – Milan
GREGOIRE PESQUES, Head of Global Corporate – London
Introduction
Along with the EUR denominated corporate bond segment, the Sterling credit market plays
an important role in matching European companies’ funding needs with corporate bond
investors’ demand.
Therefore, the aim of this focus is to provide investors with an overview of the Sterling
corporate bond market, its recent trends and the main features of the current structure,
together with its positioning in the global credit arena. In particular we analysed the
peculiarities of this market and investigated the role of long-term investors behind them: a
section is therefore dedicated to pension funds and recent news on regulation affecting their
activity. The portfolio manager’s actual view is a relevant part of the piece, offering an insight
of real market players on opportunities available to investors, especially in terms of
diversification and credit quality enhancement.
1
Market overview
a) Recent trends
The recent trends in the sterling credit market are summarised in first two graphs reported,
respectively showing trends of outstanding debt and the number of issues. Similarly to
EUR corporate bond markets, the crisis led to a rebalancing of weights between
financials and industrial issuers, the first shrinking at the expense of the latter.
1 - GBP corporate bonds: outstanding debt
in GBP bn
 Similarly to EUR corporate bond markets, the
sterling credit market experienced the effects of
crisis-induced evolutionary forces, namely a
rebalancing of weights between financials and
industrial issuers, and the sharp rise of
speculative grade debt, though from very low
levels.
 The current structure still shows a strong
presence of financials (40% of overall debt
value), while defensive sectors such as telecoms
and utilities dominate among non-financial
issuers.
 One of the most attractive features of the sterling
corporate bond market is represented by its
higher component of “non-domestic” issuers with
respect to Euro and US corporate bond markets.
UK issuers in fact account for less than 50% of
both non-financial and financial IG sterling
corporate debt.
 However, the most peculiar feature of the IG
Sterling corporate bond market is represented by
the high average duration of its debt. Modified
duration of Sterling IG corporate bonds is close
to nine years for non-financials and above six
years in the financial sector. Time to maturity
averages close to 14 years, as 40% of nonfinancial issuers have a maturity above 10 years.
 In this respect, the more duration rises, the less
outstanding debt is available in EUR corporate
bonds, while the opposite is true for GBP nonfinancial corporate bonds: the latter is the only
major provider of yield and spread in the very
long duration buckets, as EUR core financial and
non-financial debt is very limited in size.
 In a nutshell, the sterling market has strong
characteristics that can be summarised as good
quality and long dated which, in fact, are a
reflection of domestic demand. A drawback is
obviously the liquidity which, on average, is
lower than EUR or USD, as you have large
proportions of buy and hold investors.
Document for the exclusive attention of professional clients, investment services providers and any other professional of the financial industry
December 17 2014
Another similarity with EUR credit markets is represented by the sharp rise of speculative
grade debt, though from very low levels. When Lehman defaulted in September 2008, the
Sterling HY market had outstanding debt of less than GBP 10 billion, distributed across 42
issues: current outstanding debt value is worth GBP 40 billion, spread between almost 140
issues.
2 - GBP corporate bonds: number of issues
Therefore the sterling market recorded growth very similar to the remarkable growth
delivered by EUR HY over the same period, namely a four-fold increase in debt and a threefold rise in bond issues. Contrary to the experience of the EUR corporate bond market,
however, the sterling IG market started to feel a lack of debt growth immediately after the
Lehman crisis and not only a few years later, on the back of the subsequent sovereign debt
crisis of 2011. Just to mention a few numbers, the IG sterling credit market has grown by
just 8% since the Lehman default, while over the same period and despite the subsequent
sovereign debt crisis, the EUR IG corporate bond market has grown by 24% in terms of
outstanding debt. Bank de-leveraging, bank disintermediation and rating downgrades were
the same major forces behind the decline in financials’ debt in both the EUR and sterling
markets.
b)Current market structure: sectors, ratings and country of issuers
The sector breakdown shows that 40% of overall debt value is still represented by financial
sectors, with 25% accounted for by banks, 9% by insurers and the remaining 6% by
financials. As the graph shows, defensive sectors such as telecoms and utilities dominate
among non-financial issuers, respectively with 20% and 8% of overall outstanding debt, with
consumer staples accounting for 4%.
3 - GBP IG corporate bonds: sector
breakdown
Cyclical sectors play a lower role with 20% overall. The breakdown by rating sees a
dominance of A-rated names (43%) and BBB-rated issuers (42%): AA account for just
13.5% of overall debt. The most interesting part of this section, however, has to do with
country of issuers and curve buckets. One of the most attractive features of the sterling
corporate bond market is represented by its higher component of “non-domestic” issuers
with respect to the Euro and US corporate bond markets. UK issuers account for just 48%
and 45% respectively of non-financial and financial IG sterling corporate debt. Issuers
belonging to the EZ play a major role in the non-financial area, accounting for almost 30% of
debt, while financials represent 16%. The opposite is true for US issuers with banks
representing more than 30% of overall financial debt and industrials representing 14%.
Nordics and emerging issuers complete the picture and improve geographical
diversification, together with Swiss issuers. A look at sterling HY sees a much lower degree
of diversification, with 74% domestic issuers, 23% Eurozone names and practically no US
names.
4 - GBP IG Corp non-finls
by country of issuer
5 - GBP IG Corporate finls
by country of issuer
2
Document for the exclusive attention of professional clients, investment services providers and any other professional of the financial industry
December 17 2014
c) Current market structure: duration and curve buckets
The most peculiar feature of the IG Sterling corporate bond market is represented by the
high average duration of its debt. Just to mention a few numbers, modified duration of
Sterling IG corporate bonds is close to nine years for non-financials, while it is above
six years in the financial area. Time to maturity averages close to 14 years. A total of
GBP 120 billion debt or 40% of non-financial issuers have a maturity above 10 years. A
look at the speculative grade sterling bond market captures a more traditional trend,
fairly in line with the short average duration of the EUR HY market. The following
graphs, especially in the case of IG non-financials show to what extent the sterling
corporate bond market may play a role in the long duration segment in Europe. The
more important role of long-term investors is among the reasons behind this peculiar
feature of the sterling market.
6 - GBP HY Corporate bonds,
by country of issuer
Outstanding debt in GBP MM by curve bucket
2
Relative value vs EUR and US$ corporate bond
market
a) Yield and spreads: two sides of the same coin but be careful to
make homogeneous comparisons
Benchmark comparison is based on average yield or spreads offered. However, yield levels
tend to be highly dependent on underlying government bond yields, while average
spreads may be difficult to compare because of different duration levels and rating
weights. Both US and Sterling corporate bonds on average currently offer higher yields
than EUR corporates, but this is mainly due to positive government bond spreads and
higher duration. In order to build a deeper analysis we concentrated on curve buckets,
also taking into account real market debt size.
7 - GBP Corporate bonds: outstanding debt
in GBP MM, by curve bucket
As shown by the two graphs below the comparison between the GBP and EUR corporate
bond markets sees a positive yield spread across the whole curve, mainly on the back
of the relative value between corresponding government bonds. The most interesting
outcome, however, is represented by the opposite distribution of outstanding debt
among curve buckets, in the graphs represented by the size of bubbles: the more
duration rises the less outstanding debt is available in EUR corporate bonds, while the
opposite is true for GBP non-financial corporate bonds. In a nutshell, in the European
IG corporate bond market, there seems to be no real available alternative to sterling
corporate bonds at the very long end of the curve: this segment is the only major
provider of yield and spread as EUR core financial and non-financial debt is very
limited in size.
8 - IG Non-finls: EUR (Periphery and Core)
vs GBP
9- IG Finls: EUR (Periphery and Core)
vs GBP
3
Document for the exclusive attention of professional clients, investment services providers and any other professional of the financial industry
December 17 2014
The same comparison between GBP and USD corporate bonds shows a different picture
and size is clearly even more in favour of US$ market for both financials and industrials.
Relative value between the two markets differs substantially along the curve: in most of the
curve buckets and especially in low to medium duration segments, Sterling corporate bonds
offer a higher yield level while the opposite seems to be the case in the highest duration
segment.
3
10 - US$ vs GBP corporate bonds YTM
Portfolio Manager’s view
As stated above, the sterling market has strong characteristics that can be summarised as
good quality and long dated which, in fact, are a reflection of domestic demand. Not only the
corporate bond market but the whole sterling market (government bonds, linkers) is biased
toward the long end as there is a solid base of “liability investors”. This is also to some extent
the case in the USD but certainly less in the EURO denominated markets. UK liability
investors such as pension funds and insurance companies have longer liabilities and
represent a bigger share of the domestic investor base. A drawback is obviously the liquidity
which is on average lower than EUR or USD as you have large proportions of buy and hold
investors. Average issue size is also lower. The chart below outlines some similarities
between the GBP and EUR markets, as both have a very high level of concentration risk: the
top 100 issuers accounted for more than 75% of the risk of their universe. To reach this
level, you need close to 300 issuers on the global or USD benchmark. As a result, it is more
a story of beta. It carries less alpha (stock picking) opportunities.
So let’s detail how an investor can benefit from the UK sterling market.
First of all, as mentioned, any GBP denominated liability manager will naturally favour the
UK corporate market as it will be easier to match interest rate (UK interest rate), currency
and maturity with its domestic market.
For global investors, the UK market can offer:
Rate Diversification: A good way to benefit from diversification (UK rates and curves are
not 100% correlated with the EUR, for example, and we can extract of a lot of value in
dynamically managing the EUR-UK spread). That’s interest rate exposure.
11 - Total credit risk (in %, Y axis) and
number of issuers (X axis)
Spread Diversification: Benefit from the different spread trends: for example, the UK
corporate market outperformed the EUR and the USD credit market by 13% and 9% over the
past five years. Just the spread effect! So, actively managing the allocation between the
zone can add a lot of value. That’s beta-credit allocation.
The issuer effect: some issuers are mostly investable in GBP denominated bonds.
The issue effect: most investors are highly segmented. It creates dislocations and relative
value opportunities. The same issuers can offer different spreads whether the issue is in
EUR, USD or GBP. Cross currency can generate significant regular alpha. In addition to
actively managing the geographical allocation, issue selection (based on not only maturity or
subordination but in this case currency of denomination) is key and can generate significant
value. As an example, for the same issuer, the euro (maturity 2029) tightened by nearly
25bps recently to yield 2.60%, while the 2023 spread (six years shorter) in GBP remained
unchanged at 150bps, offering a yield of 3.75. We can see that actively managing relative
values can offer great opportunities for marginal incremental risk.
4
Document for the exclusive attention of professional clients, investment services providers and any other professional of the financial industry
December 17 2014
> The UK’s pension system
Assets held in pension funds in 2011
(in bn £)
Self-adminstered pension funds,
accumulation and decumulation
phase
The UK's pension system is one of the oldest in Europe. It was developed by entrepreneurs
at the start of the industrial revolution. The funded pension scheme is historically dominant
and relies on private sector employees and employers via private insurers. These two
industries are strictly regulated. The value of assets held in pension funds is over £2 trillion,
representing 135% of GDP.
When he presented the budget last March, George Osborne confirmed a significant change
in the UK pension system. The new system's goal is to provide pensioners with more
flexibility. At 55 years of age, they will be able to start withdrawing assets from their
retirement funds, at their discretion and with no annual limit, rather than collecting annuities.
The annuity payment system has been penalised in recent years by low key interest rates.
To encourage UK pensioners to withdraw capital, the Government will also introduce a tax
incentive. This reform transfers longevity risk to pensioners.
217;
10%
Occupational pensions
administered by insurance
companies, accumulation phase
303; 15%
76;
4%
1444; 71%
Personal pensions administered by
insurance companies,
accumulation phase
Annuities and income drawdown
administered by insurance
companies, decumulation phase
What are the amounts at stake? The government estimates that these pension funds' assets
represent an annual investment flow of £11 billion and holdings of £210 billion. More than
half of these assets (£100 billion to £150 billion) are invested in corporate bonds. The
annuity payment system is therefore a significant support for the UK bond market,
particularly in the 10- to 30-year segment.
This change in the UK's pension system will impact the UK bond market. UK IG credit
remains attractive. However, after the reform, investors are expected to favour medium-term
over long-term segments.
Fewer long-term primary issues. Greater demand for maturities shorter than 10 years.
Steepening of the curve. Investors must have a premium to be attracted to the long end of
the curve.
Conclusion
Similarly to EUR corporate bond markets, the sterling credit market experienced a
rebalancing of weights between financials and industrial issuers along with the sharp rise of
speculative grade debt, albeit from very low levels. One of the most attractive features of the
sterling corporate bond market is represented by its higher percentage of “non-domestic”
issuers with respect to euro and US corporate bond markets. UK issuers in fact account for
less than 50% of both non-financial and financial IG sterling corporate debt. However, the
most peculiar feature of the IG sterling corporate bond market is the high average duration of
its debt. In this respect, the more duration rises, the less outstanding debt is available in
EUR corporate bonds, while the opposite is true for GBP non-financial corporate bonds: the
latter is the only major provider of yield and spread in the very long duration buckets, as EUR
core financial and non-financial debt is very limited in size. The sterling market is
characterised by good quality and long duration which, in fact, are a reflection of domestic
demand. Liquidity is obviously a drawback as it is, on average, lower than EUR or USD, due
to large proportions of buy-and-hold investors.
5
Document for the exclusive attention of professional clients, investment services providers and any other professional of the financial industry
December 17 2014
Editor
Philippe Ithurbide - Head of Research, Strategy
and Analysis – Paris
Support
Pia Berger - Research, Strategy and Analysis Paris
DISCLAIMER
Chief editor: Pascal Blanqué
Editor: Philippe Ithurbide
In the European Union, this document is only for the attention of “Professional” investor as defined in Directive 2004/39/EC dated 21 April 2004 on markets in financial
instruments (“MIFID”), to investment services providers and any other professional of the financial industry, and as the case may be in each local regulations and, as far as
the offering in Switzerland is concerned, a “Qualified Investor” within the meaning of the provisions of the Swiss Collective Investment Schemes Act of 23 June 2006 (CISA),
the Swiss Collective Investment Schemes Ordinance of 22 November 2006 (CISO) and the FINMA’s Circular 08/8 on Public Advertising under the Collective Investment
Schemes legislation of 20 November 2008. In no event may this material be distributed in the European Union to non “Professional” investors as defined in the MIFID or in
each local regulation, or in Switzerland to investors who do not comply with the definition of “qualified investors” as defined in the applicable legislation and regulation.
This document neither constitutes an offer to buy nor a solicitation to sell a product, and shall not be considered as an unlawful solicitation or an investment advice.
Amundi accepts no liability whatsoever, whether direct or indirect, that may arise from the use of information contained in this material. Amundi can in no way be held
responsible for any decision or investment made on the basis of information contained in this material. The information contained in this document is disclosed to you on a
confidential basis and shall not be copied, reproduced, modified, translated or distributed without the prior written approval of Amundi, to any third person or entity in any
country or jurisdiction which would subject Amundi or any of “the Funds”, to any registration requirements within these jurisdictions or where it might be considered as
unlawful. Accordingly, this material is for distribution solely in jurisdictions where permitted and to persons who may receive it without breaching applicable legal or regulatory
requirements.
The information contained in this document is deemed accurate as at the date of publication set out on the first page of this document. Data, opinions and estimates may be
changed without notice.
You have the right to receive information about the personal information we hold on you. You can obtain a copy of the information we hold on you by sending an email to
[email protected]. If you are concerned that any of the information we hold on you is incorrect, please contact us at [email protected]
Document issued by Amundi, a société anonyme with a share capital of €596,262,615 - Portfolio manager regulated by the AMF under number GP04000036 – Head office:
90 boulevard Pasteur – 75015 Paris – France – 437 574 452 RCS Paris www.amundi.com
Document for the exclusive attention of professional clients, investment services providers and any other professional of the financial industry