Technical backdrop for High Yield less favourable in 2007?

As many of you will be aware we have been concerned about the high yield market for a while now. Historically tight spreads do not, we believe, adequately reward investors for the risks that they are being asked to take although we have been well aware of the technical picture which has proved supportive of spreads. However, a piece put out by JP Morgan yesterday highlighted a few interesting points.

The European High Yield Market (EHY) was characterised in 2006 by a supply demand imbalance. Issuance during the year totalled €28bn. At the same time we saw redemptions of €22bn (ie bonds that matured or were refinanced), coupon payments of €5-6bn as well as what JP Morgan describe as a ‘significant capital inflow’ into the market. These technical go some way to explaining the 11.10% total return for the Merrill Lynch European High Yield Index in 2006. The obvious question, will they persist in 2007?

JP Morgan calculate that €6.2bn of paper is due to mature in 2007. Currently a further €3.5bn of high yield debt is trading above its call price incentivising companies to repay this debt which suggests €10bn may be repaid to investors. This is significantly less than what we saw in 2006. Clearly there will be further unexpected refinancings though I’d suggest these are unlikely to make up the shortfall. Could a large LBO and subsequent EHY issuance prove to be the straw that breaks the camels back?

The value of investments will fluctuate, which will cause prices to fall as well as rise and you may not get back the original amount you invested. Past performance is not a guide to future performance.

Stefan Isaacs

Job Title: Deputy CIO Public Fixed Income

Specialist Subjects: Bonds

Likes: Football, travel and the prospect of retirement

Heroes: Sir David Attenborough, Bill Shankly and Theodor Herzl

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