Why US high yield looks better value than Europe in 2015

Phil Milburn, the manager of Kames Capital’s £1.5bn* High Yield Bond Fund, has identified why he believes US high yield bonds are more attractive than European counterparts in the current environment.

Milburn, who runs the fund alongside co-manager Claire McGuckin, says while US high yield bond returns lagged European debt by 3% last year, this was largely driven by the December rout in the energy sector, with returns ex energy closer to Europe. He believes that a combination of factors including attractive yields and stronger growth in the US makes the region a better opportunity for investors this year.

“Whilst Europe started 2015 strongly – with the January Barclays European High Yield index up 1.1% versus the US index gain of 0.7%, the US has overtaken in February driven by a rebound in energy sector bonds and continuing strong economic data” Milburn says.

“Europe has effectively reset risk appetite following the Phones4U debacle in the second half of last year, and while this and the announcement of ECB QE had a positive impact in January, the fact is the US has stronger credit to invest in offering more attractive yields.”

Milburn has identified a number of reasons why he expects US high yield to outperform this year.

“Firstly, valuations are more attractive for US debt now, with a yield to worst of 6.1% versus just 3.8% in Europe,” he says. “We think, with the yields available, we could make between 5-8% this year by investing in US high yield.”

“Simply by playing the carry trade, US high yield should deliver an additional 0.2% per month versus Europe this year, given the starting position of both regions in January,” Milburn said.

“Then you have to consider the underlying strength of the two economies. This year is about returning to fundamentals, and the US economy is currently growing much faster than Europe.”

The latest growth figure for the US showed the economy expanded by 2.6% in Q4, compared to no growth in the Eurozone.

Of course, this growth is double-edged for bond investors as it also means the US Federal Reserve is now expected to raise rates as early as the summer, while the European Central Bank is embarking on an easing programme. While this is undoubtedly a headwind for US bonds compared to European debt, Milburn says a lack of inflation means the Fed is not about to embark on a major tightening programme.

“The scale of any rise will be minimal, and by using US Treasury futures we can hedge the rate sensitivity of some of the longer-dated bonds in the fund,” he says.

In the current environment, liquidity also remains a key consideration for fixed income investors, and Milburn believes here too the US has the upper hand over Europe.

“Given we expect central bank policy to finally diverge this year, 2015 will be volatile, and being able to trade without the fear liquidity could vanish will become even more important,” he says. “The US offers better liquidity at present, and therefore looks more attractive on this basis.”