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WHY INVESTORS STILL NEED EUROPEAN CREDIT By Tobias Stein
The European credit market has grown considerably since the advent of the European Monetary Union (EMU) and the euro in 1999. Despite its growing importance, investors in the current market environment are faced with negative yields and vanishing liquidity. Nevertheless, important reasons remain for an allocation to this segment. common currency, especially in the aftermath of the euro crisis in 2011. Multi-national issuers especially have embraced the market as a diversifying source of funding, taking full advantage of the ultra-low yield environment. Whereas the number of outstanding issues has tripled over the last 20 years, average duration has been relatively stable (in contrast to the European sovereign bond market, where a noticeable duration extension has taken place), which forms a good basis for empirical analysis.
Photo: Archive Quoniam AM
The introduction of the euro in 1999 within the EMU countries was the origin of the European credit market. Over the last 20 years, the market has grown considerably – early and expected domination by European issuers from EMU core countries has evolved into a market featuring global issuers from developed and emerging markets. Nowadays, the share of investmentgrade issuers outside the eurozone represents more than 40% and has been steadily growing despite frequent doubts about the survival of the
Tobias Stein
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FINANCIAL INVESTIGATOR
NUMMER 5 / 2019
For an investor faced with the current capital market environment, the question is whether an allocation to this market segment still makes sense. Specifically, is the risk-return profile replicable with a combination of sovereign debt and equity investments, or does credit deliver some additional benefit?
SUPERIOR RISK-RETURN PROFILE Measured with a standard market index, since 1999 an investor in investment grade European credit has achieved about 2.5% excess return per annum versus the money-market, with an annualised volatility of about 3.3%. Pure credit-excess return was about 0.8%; the remaining 1.7% represents the realised term premium of duration-matched German sovereign bonds (Bunds). During the same period European equities yielded an excess return of about 3.7%, but of course exhibited significantly higher volatility of about 15%. Thus the risk-adjusted returns were historically far more favourable for corporate bonds. At the height of the euro crisis in July 2012, ECB president Mario Draghi’s famous speech to do ‘whatever it takes to preserve the euro’ marked a significant turning point for risk markets. Since then, volatility of the different risk premia has declined between 20% and 30% (see Figure 1). While the realised term premium was the same compared to the full sample result, credit-excess and
