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Corporates kick-off: investors react as ECB readies purchases

Corporates kick-off: investors react as ECB readies purchases

The European Central Bank set out its stall for purchasing corporate bonds at its latest meeting, with Mario Draghi announcing a June 8 kick-off date for the additional bond-buying measure.

Draghi had outlined plans, known as CSSP, to expand the scheme to cover investment grade non-financial corporate bonds in March but has remained tight-lipped on the actual size and scope of purchases in this area.

The bond-buying scheme as a whole was expanded in March from €60 billion-per-month purchases to €80 billion-per-month, albeit without the ECB stating whether the extra €20 billion would focus solely on corporate bonds.

However, is the ECB announcing it is in the market enough to stimulate positive responses among investors? Citywire Selector canvassed top investors to find out.

Distortion is disturbing

Mitch Reznick, co-head of credit at Hermes Investment Management, believes the ECB imposition is having a knock-on effect but not perhaps in the way the central bank would want.

The prospect of a determined, deep-pocketed buyer in primary and secondary bond markets sent credit spreads tighter as it triggered a land-grab for credit. When an exogenous factor like the CSPP is driving credit spreads, valuations become distorted.

For example, approximately 10% of European IG credit is offered at negative yields. We do not believe chasing idiosyncratic and/or liquidity risks is the correct response to this valuation anomaly. Rather, mandate-permitting, there are other options out there in order to deliver superior, risk-adjusted returns.

From here, European spreads can only rally so much relative to other geographies, and risk falling faster than they can rise – a concept known as convexity that exposes the asymmetric return profile of bonds, and reveals the risk of buying credit at its most expensive, or when trading to call.

Convergence concerns

According to Jon Jonsson, manager of the Neuberger Berman Global Bond Absolute Return fund, investment grade companies may over-extend themselves, while the programme could be problematic for bondholders.

The extent of the ECB’s purchases and the long maturities it is prepared to buy will make the euro investment grade corporate universe look more and more like the core government bond market.

More significantly, the presence of such a substantial new buyer in the primary market is likely to make it easier for issuers to demand more favourable terms from investors, while the purchase programme’s eligibility criteria may preclude some investor-friendly characteristics, too.

Overall, however, the programme should be positive for European credit. In the short term, spreads are likely to tighten, and over the longer-term it is likely to reduce the cost of capital for larger, bond-issuing companies, increase the liquidity being provided for small and medium-sized enterprises.

Face it: Brexit is bigger

Euan McNeil, who manages several funds at Kames Capital including the Kames Investment Grade Global Bond fund with the Citywire + rated Stephen Snowden, thinks any positive impacts of the scheme will be outweighed by Brexit in the short term.

I think our immediate concern is that fears around Brexit are likely to overshadow the medium term positive benefits of ECB buying programme. On a medium-term basis, we think it is undoubtedly a positive for the market. But in the short term, the ongoing uncertainty around Brexit might just act as a counter balance.

Until it starts we won't have a perfect idea of how it will work. The one thing I took away from it is I don't think they are duty bound to spend €10 billion-a-month. If individual central banks have said that if liquidity is not there in a particular month then they are relaxed about not hitting the €10 billion-a-month target for one month. I don't think it is a religious formulaic €10 billion-a-month they are going to do. I think it will be dependent on market conditions.

Referendum on the radar

Citywire + rated Philippe Gräub, deputy head of bonds at Union Bancaire Privée, says there will be positive technical effects but wider macro matters cannot be ignored.

We are more cautious about the overall market impact given that i) valuations are already stretched in investment grade EUR with yields at 1.0% and ii) the market initial response to the CSSP announcement was somewhat modest given that it occurred in an overall bullish environment (oil price rallying).

In addition, looming ahead for European credit is the UK referendum. Euro-denominated credit of European names look more vulnerable than USD credit to a negative market reaction after the referendum.

Bond-buying is bad news

Offering a strong opposition to the programme is Rubrics’ Matthew Barnes. The Citywire A-rated manager said the ECB intervention would do more harm than good.

We fail to see the benefits of the ECB bond buying programme. In our view ownership of low-yielding euro-denominated senior unsecured corporate bonds at current yields will prove to be a value destroying exercise over the long-term. We think now remains a good time to selectively go down the debt-capital structure into corporate hybrids.

Today many European investment-grade corporate hybrid issuers enjoy superior financial flexibility from lower funding costs and a more staggered debt maturity profile than was the case pre 2008, as older legacy senior unsecured debt has been progressively replaced by cheaper and longer dated senior unsecured funding.

Looking in wrong direction

Citywire + rated Gareth Isaac, who manages several fixed income funds at Schroders, thinks that the ECB is doing all it can to help the economy, but the bond-buying programme is targeted at the wrong part of the market.

The market has already front-run the buying to a certain extent because credit spreads are down quite dramatically and we have seen a significant pick up. Especially in terms of American companies issuing to the European market because spreads have tightened even though they are not eligible for the bond-buying programme.

European corporates have been able to borrow at relatively cheap rates for some time. So whether reducing it from large cap corporations will actually have much impact, I very much doubt it.

I think in small and medium-sized enterprises is where you need to get the borrowing out and that is not going to be affected that much by the corporate bond buying programme of the ECB. That is the part of the market which has been starved of cheap credit since the financial crisis.

I do think doing it through the credit channel, trying to encourage corporates, because their cost of funding has fallen, I think is the next stage of this QE. If you were to reign back on government QE there would be a sizable impact on the government bond market.

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