The UK credit market has experienced heightened volatility and underperformed the rest of the world ever since the Brexit vote in 2016. But this year marked a turning point, as progress in avoiding a no-deal exit from the European Union helped all UK assets perform well.
The Conservative Party victory at the general election last week also helped market sentiment, as did positive momentum in US-China trade talks. This led to the European Crossover Credit Default Swap Index trading at all-time tights, while implied volatility in equity markets – as measured by the VIX – hit its lowest level in a year.
Dispersion within the market is still elevated and investors need to differentiate between credits that are positioned to weather the challenging macroeconomic environment and those that might need to trim their debt load to survive. In particular, defaults have increased among energy companies and the sector has become the largest contributor to volatility.
Yet even after a strong move in sterling credit this year, valuations still look attractive on a relative-value basis (see figure 1).
Figure 1: UK instruments offer attractive relative value
Source: Hermes Credit, ICE bond indices, as at December 2019.
Back in 2016, sterling high yield delivered 275bps less than the global average. Today, it offers 50bps more. Sterling sub insurers are also trading wide relative to the European market, which has outperformed as the European Central Bank’s Corporate Sector Purchase Programme encourages asset allocators to move into subordinated instruments.
When coupons are at historical lows, looking at relative value within credit markets is more important than ever. Read more about how we approach top-down capital allocation in our recent thought piece, ‘Flexible credit: all weather allocation’.