As we sit at our desks here in Edinburgh, and survey the global high yield bond markets via our computer screens, we can see that GBP-denominated securities trade at much higher credit spreads than their EUR and USD-denominated brethren.
Looking at the chart below, we can see that GBP-denominated corporate bonds rated BB offer a credit spread of 246bps, compared to 212bps for EUR and 220bps for USD. The distinction is much larger for single B rated corporates – GBP-denominated bonds offer a spread of 504bps compared to 376bps for USD and 446bps for EUR. “That’s fair enough”, you might say, “GBP corporate bonds deserve to trade with an additional credit spread because of the risks surrounding the possible economic impact of Brexit”. For many investors that manage money on a top-down basis, the analysis stops here.
However, if we dig deeper and look at some of the individual credits, we can identify plenty of opportunities for the bottom-up global investor. Although there is indeed a “Brexit premium” required for a number of GBP-denominated bonds, for example those issued by domestic consumer cyclicals, there are also many situations where cross-currency issuers see their GBP-denominated bonds trading at a discount. We can see some examples of this in the table below.
In each case the bonds shown rank pari-passu (a Latin phrase meaning “equal footing”) in the capital structure. Therefore default risk is identical. We have tried to match the maturity dates of each pair as closely as possible, though they are not all exactly the same.
The table above contains a mix of multinational and domestic businesses which are sufficiently large to have bonds outstanding in multiple currencies. We can see for every issuer shown, the GBP-denominated bonds compensate noteholders with a material extra credit spread. (Note: looking at credit spread rather than yield isolates the compensation for default risk by removing the government bond yield component that compensates investors for the prevailing interest rate environment in each currency). We believe this valuation disparity has occurred because top-down investors, in their desire to avoid Brexit-related risks, have sold down GBP-denominated assets without considering the credit quality of the underlying borrowers or the valuations of the particular bond issues.
For those investors that can operate on a global basis, and are not tied to specific currencies, there are opportunities to be had in lending in GBP to strong individual borrowers, while avoiding the risks associated with Brexit.