Is there value left in European fixed income?

By BlackRock

Key takeaways

  • Credit provides an attractive yield pick-up vs government bonds as volatility is suppressed by the ECB
  • Fundamentals are generally strong but with dispersion on a name by name basis, favouring an active approach
  • Relative value style takes advantage of numerous market dislocations in both rising and falling markets
  • This is why we favour European Corporate Bonds as an attractive low volatility yield play with an upside potential from strong alpha generation.


Strong fundamentals supporting Euro credit

Appetite for Euro credit continued to be strong going into autumn, with the Barclays European investment grade index delivering an excess return of 1%1 during Q3. Central bank activity dominated market sentiment, as the European Central Bank (ECB) ramped up the pace of its corporate bond purchases in September, buying €29.7 billion2 of corporate bonds over the month.

Away from central bank activity, we continue to see strong fundamentals in the non-financial space as well as improving capitalisation and regulatory clarity for banks that provide support for credit valuations going forward.

The right approach right now

Ultimately, the ECB’s actions and their aftermath have reverberated across European credit markets, creating valuation anomalies on which active managers can capitalise. We believe this is a fertile time to be looking at relative value opportunities within broader European fixed income as well as inside Euro IG markets, where we see dislocations between ECB eligible and non-eligible assets, and between government bonds and credit bonds in the Eurozone periphery.

Further, we believe European banks offer interesting value in subordinated space. While one can argue that beta returns have largely played out, an active approach has the potential to unlock considerable amount of alpha for investors.

Credit markets remain attractive in a low-yield world in our view, given the strong fundamental outlook and additional support of central bank asset purchases in the Eurozone and UK. The ECB’s new corporate bond purchase program may provide support, even for areas not directly impacted by the program such as hybrids and subordinated financials.

Outperformance in rising and falling markets

The BGF Euro Corporate Bond Fund is a diversified portfolio that targets many sources of alpha to generate value and maximise returns. Diversification and comprehensive risk management mean no single factor or security can risk overall performance. Active risk is spread across countries, sectors, securities, duration and yield curve positioning, while currency exposure is flexibly managed. This relative value based approach may help to build returns gradually rather than taking high potential but risky positions.

Don't take any unnecessary risks.

The Fund’s size (€1.7bn3) allows active returns to contribute more meaningfully to total returns than would be possible in a much larger portfolio. A focus on investment-grade bonds, rather than skewing our exposure towards lower quality credit in search of yield, reduces both credit risk and volatility. The Fund has performed consistently strongly since Tom Mondelaers began managing it in July 2009. Since then, the Fund has outperformed when markets have risen (by 1.37% on an average annualised basis and fallen by 1.16% on the same basis3).

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1Barclays, September 2016
2ECB, September 2016
3BlackRock, 30 September 2016.The fund has delivered 8.74%, 6.07%, 7.24%, 6.88% over the past 1, 3 and 5 years respectively and 6.88% since inception (gross).

The risk indicator shown on this document refers to the A share class of the Fund. Higher or lower risk may apply to the other share classes of the Fund.

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Fund Specific risks: Overseas investment will be affected by movements in currency exchange rates. Two main risks related to fixed income investing are interest rate risk and credit risk. Typically, when interest rates rise, there is a corresponding decline in the market value of bonds. Credit risk refers to the possibility that the issuer of the bond will not be able to repay the principal and make interest payments. Fixed income securities issued by governments can be affected by the perceived stability of the country concerned and proposed or actual credit rating downgrades. The Fund invests in fixed interest securities issued by companies. There is a risk of default where the issuing company may not pay income or repay capital to the Fund when due. The Fund’s investments may have low liquidity which often causes the value of these investments to be less predictable. In extreme cases, the Fund may not be able to realise the investment at the latest market price or at a price considered fair. The fund invests in fixed interest securities such as corporate or government bonds which pay a fixed or variable rate of interest (also known as the ‘coupon’) and behave similarly to a loan. These securities are therefore exposed to changes in interest rates which will affect the value of any securities held. The fund may invest in structured credit products such as asset backed securities (‘ABS’) which pool together mortgages and other debts into single or multiple series credit products which are then passed on to investors, normally in return for interest payments based on the cash flows from the underlying assets. These securities have similar characteristics to corporate bonds but carry greater risk as the details of the underlying loans is unknown, although loans with similar terms are typically packaged together. The stability of returns from ABS are not only dependent on changes in interest-rates but also changes in the repayments of the underlying loans as a result of changes in economic conditions or the circumstances of the holder of the loan. These securities can therefore be more sensitive to economic events, may be subject to severe price movements and can be more difficult and/or more expensive to sell in difficult markets.