European high yield didn’t benefit from the currency upside of its US counterpart, and has had its worst year since 2011, returning only 1.3%. Fund selectors were actually rather pessimistic about high yield bonds a year ago, with those planning to decrease their exposure significantly outnumbering those intending to increase it in all countries except Finland, Italy and Portugal. On a Pan-European basis, just one in ten fund buyers planned to step up exposure in December 2014, while a third were looking to decrease it. So, when correcting for the currency distortion in US high yield, it should be concluded that most of Europe’s fund selectors got their sentiment call right.
It really was all about currency
Emerging market local currency debt didn’t have the currency cushion of US high yield bonds. The trouble the asset class went through in the second half of the year has been well-documented. This year, the JPM GBI-EM Global Composite Index (which is composed of local currency government bonds) is down almost 8% in euro terms.
However, emerging market corporate bonds, which tend to be denominated in dollars, enjoyed their currency upside and returned close to 11% to euro-based investors. So did fund selectors anticipate on this discrepancy?
EM corporate debt was clearly the most popular of the two. Switzerland and Portugal were the only two countries where the opposite was true. However, buyers of EM govvies also outnumbered sellers on a Pan-European basis. And, when corrected for the currency distortion, EM corporate bonds were a slightly loss-making investment in 2015. So overall, fund selectors were probably a little too optimistic about emerging market debt at the end of the year.
As a concluding note, we can say without doubt that a rather extraordinary bond year is behind us, in which currency was an unusually prominent factor in driving returns. It’s therefore hard to say whether the allocation calls of Europe’s fixed income fund selectors made sense. But those who were overweight to dollar-denominated debt certainly had an edge throughout the year.
