- The global economy is showing signs of synchronized recovery in 2018, with economic activity growing solidly and unemployment falling. However, loose monetary policy has not yet translated to clearly rising wage and inflation levels. - In 2017, the European high yield bond market performed well, with funds returning around 5% on average. Defaults remained low and are expected to stay low in 2018. - Spreads have tightened but remain in the lower historical range, offering carry and diversification benefits for fixed income investors seeking yield in the current low interest rate environment. However, spreads may widen again if economic growth accelerates and core rates rise.

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High Yield Bonds in 2018: living in a low-default
world
By Bernard Lalière and Marc Leemans, CFA
Senior Portfolio Managers, Degroof Petercam AM
In the past two years, the European economic cycle has caught up significantly, and is doing very well today from a
cyclical point of view. All sectors are recovering, and the labour market is thriving again.
Ten years after the onset of the financial crisis, the global economy is finally showing signs of a synchronized recovery.
Economic activity performs solidly, trade volumes are growing, corporate profits are on the rise and unemployment is
falling.
The combination of extremely loose monetary policy, relatively low commodity prices (though industrial metal and
energy prices have rallied more recently) and neutral fiscal policy is coming to fruition. So far, however, this has not
trickled down into clearly rising wage and inflation readings.
Hence, it does not come as a surprise that investor sentiment is at quite high levels. Cash positions among retail
investors are very low, indicating their high levels of confidence.
In view of the quest for yield that many investors are pursuing, it is a good moment to look at what the EUR High Yield
bond market did in 2017, and what 2018 may have in store.
Against the context of extremely low interest rates on core sovereign bonds in Europe and the US, 2017 saw a pick-up
in risk tolerance. This has resulted in investors flocking to higher yielding bonds.
Good performances
2017 performance was quite good. Degroof Petercam AM’s flagship fund returned a solid 5%.
The spread widening in November subsided toward year-end. After the record issuance in 2017 (EUR 93.7bn, better
than the previous record seen in 2014), we expect the primary market to be active again in 2018. Things will also
depend on a pick-up in M&A and reverse Yankee issuance.
Defaults are low and we expect them to remain low. This is shown in the graph below, courtesy of S&P.

2. Brussels, 09 February 2018
There could be a couple of isolated cases, for example Angel Steinhoff, which active management may avoid.
In the US, defaults are edging lower as is the number of distressed bonds. The late cycle economy may entail more
M&A at top dollar valuations going forward, meaning less creditor friendly deals. However, sentiment in the US
remains very bullish and might lead to a strong market in the first half of 2018.
Tighter spreads, lower yields
When looking at option-adjusted spreads of EUR High Yield, we have seen some widening towards year-end 2017.
Indeed, in December 2017 spreads stood at 278bps while the low in 2017 was 214bps. This is still way below the
average option-adjusted spread since 2001, which stands at 588bps.
Positioning and outlook
Currently, B-rated issues offer more value after the spread widening seen in the last two months. Duration of the high
yield category has gone up to 4.6 years due to the combined effect of longer-dated maturities and lower coupons. This
mainly affects the BB space, where new issuance in the last two years has partly been absorbed by investment grade
(IG) investors that can go down the ratings scale and buy lower-rated paper. These investors might leave the space
once the spread differential with IG becomes more favorable to IG again. Further, against a backdrop of increasing
core rates, longer duration BBs might be hit harder than B-rated bonds. Given the strength of the global economy and
as unemployment data is reaching multi-year lows, we have a slight preference for credit risk over duration risk.
All in all, we still see value in European high yield. M&A and more shareholder-friendly actions are positive for the
asset class, while the looming end of the ECB’s corporate bond purchasing program might impact spreads. Credit
spreads have narrowed to the lower historical range, however, they still offer carry and diversification benefits among
fixed income and equity investments.

3. Brussels, 09 February 2018
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Present documents do not constitute investment advice nor do they form part of an offer or solicitation for the purchase of shares, bonds or
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