Junk-rated company bonds should return 13 percent this year, giving the best trade-off between risk and return in Europe’s credit markets, according to analysts at Royal Bank of Scotland Group Plc.
Large companies at the top of the high-yield ratings spectrum no longer need to rely on banks for the majority of their funding and can issue bonds in a variety of currencies, according to analysts led by Alberto Gallo in London. They said that the deteriorating outlook for growth is hurting, particularly in peripheral countries, though such issuers generate about 65 percent of their revenue abroad.
“Even with stagnant growth and lending activity, high- yield companies have little refinancing to do and will be able to repay their debt,” according to the analysts. “Current valuations compensate for the macroeconomic deterioration.”
Slower economic growth typically causes defaults to increase, sapping returns as weaker companies struggle to refinance their borrowings amid declining revenue. While RBS expects the default rate to rise to 4 percent this year, high- yield companies have to refinance just 3 percent of outstanding bonds, according to the Edinburgh-based lender.
Even so, now may not be the right time to buy junk debt because yield spreads should be wider than current levels, the analysts wrote.
European high-yield bonds generated returns of 11.1 percent this year, after gaining 12.7 percent through the end of March, assuming re-invested coupons, according to Bank of America Merrill Lynch’s Euro High Yield Constrained Index. That compares with a loss of 2.5 percent in 2011 and a 14.7 percent gain the year before, the index shows.
Junk bonds are rated below Baa3 by Moody’s Investors Service and BBB- by Standard & Poor’s.
A “small correction” is likely, based on both the economic outlook and the inflows into high-yield funds that have helped drive the market this year, the analysts wrote.
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