Riskiest Bank Bonds Attract Aviva as European Defaults Slide

Mar 24, 2014 5:23 am ET

(Updates with French manufacturing data in fifth paragraph.)

March 24 (Bloomberg) -- Aviva Investors sees value in some of Europe’s riskiest bank debt as defaults in the region decline amid signs of economic stability.

The money manager, part of the U.K.’s third-largest insurer, is buying bonds further down the capital structure, including so-called contingent convertible notes that can flip into equity or can be written down to absorb losses in a crisis, after the worst start to a year for dollar-denominated junk debt since 2009. About 25 percent of Aviva Investors’ global high- yield bond fund is dedicated to Europe, up from about 15 percent a year ago, according to Todd Youngberg, who manages some $4 billion of assets from Chicago as head of high yield.

“Some contingent convertible bonds look interesting,” he said in an interview in Hong Kong on March 19. “We think with the regulatory support over the near term and the improving fundamentals boosting balance sheets, we’re picking up some pretty nice yield premiums.”

Europe’s economic recovery is strengthening with the euro area on track to record annual growth in 2014 for the first time in three years, according to forecasts by the International Monetary Fund and European Central Bank. Junk bond defaults in the region are poised to tumble to 1.6 percent by December from 3.5 percent last month as U.S. defaults climb to 2.3 percent from 1.6 percent over the same period, according to Moody’s Investors Service.

CoCos Trump

French manufacturing unexpectedly resumed growth in March, expanding at the fastest pace in almost three years, according to a preliminary gauge of activity released by Markit Economics Ltd. today. U.S. factory output probably slowed this month, according to the median estimate of 18 analysts surveyed by Bloomberg News.

Speculative-grade bond gains are likely to be limited this year because prices already reflect a lot of positive news, Aviva Investors said last month, as it cut its total return forecast for global high yield. Bank of America Corp. expects banks’ subordinated bonds, particularly CoCos, to perform well in 2014, analysts wrote in November.

Contingent convertible debt gained 2.68 percent last month, beating the 1.92 percent return of global high-yield securities, Bank of America Merrill Lynch indexes show. CoCos sold by Barclays Plc, the U.K.’s third-largest bank, gained 3.24 percent this year, Bloomberg prices show. Senior unsecured notes issued by the lender returned 0.29 percent over the same period.

Aviva Investors is also buying lower-rated companies to lock in higher yields, and is overweight B and CCC graded corporates, Youngberg said.

‘Buying Opportunity’

While Aviva offers clients a dedicated Asian high-yield product managed out of Singapore, it has so far not added Asian notes to its global fund, said Youngberg.

“Political volatility drives returns, as we’ve seen recently, and we try to separate that the best we can and really focus on pure corporate risk,” he said. “We really don’t have any exposure in Asia right now, but that will likely change in the coming years as that market continues to mature.” Recent signs of distress in China may create buying opportunities regionally, he said.

Shanghai Chaori Solar Energy Science & Technology Co., a Chinese maker of energy cells which convert sunlight into power, earlier this month became the first company to default in the nation’s onshore bond market. Yield premiums on dollar debt sold by Chinese borrowers have risen 25 basis points since Chaori Solar failed to fully pay a coupon on March 7, while spreads on securities from around the region widened four, according to JPMorgan Chase & Co. indexes.

“China will most likely have to start accommodating defaults,” said Youngberg. “If that impacts companies within regimes we’re comfortable with, that could be a tremendous buying opportunity. We’re looking at it for an entry point but not seeing one right now.”