The quest for yield

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Nicolas Chaput, CEO & co-CIO at Oddo AM, and Laurent Denize, co-CIO at Oddo AM, share their views on European bonds and equities.

The ECB’s massive injection of liquidity on the market has triggered historically low interest rates in the euro zone.

Ten-year sovereign bonds offer an average gross yield of 0.50% and high-grade corporate bonds are hardly more attractive, with average five-year yields of no more than 1%.

These very low levels, which will probably remain very low in the medium term, are steering investors away from a heavy allocation in core bonds, the traditional channels of “risk-free” rates.

However, we still see some opportunities to boost returns on euro zone investments.

Within high yield bonds, overweight B ratings

European high yield on the whole remains attractive, with average yields still close to 4.60%.

In this segment, we are overweighting B-rated paper, which has been neglected since summer 2014 and currently offers an attractive yield to maturity of 5.80%, vs. 3% for BB-rated paper.

With default rates still very moderate (2% at year-end, according to Moody’s) and far-off maturities (thus limiting short-term risk), we are rolling out this strategy in our high yield and diversified portfolios.

Overweight high-yielding equities but in targeted fashion

With a dividend yield of almost 3.40%, European equities are still the asset class worth overweighting.

Moreover, many companies have heavy stores of cash to buy back shares. Buybacks are highly accretive transactions that raise net earnings per share while optimising companies’ cost of capital.

They are a way to create lots of value in a low-interest-rate environment. Buybacks have not yet really begun in Europe.

US companies, however, have made some major buybacks (totalling about $500bn in 2013 and $900bn in 2014), thus providing a lift to their share prices. We expect this trend to emerge in Europe.

However, the ability to pay out a dividend is something that must be assessed over time. Hence, the importance of selecting companies able to generate cash flow on a sustained basis.

To cite one example, we tend to underweight oil and other energy stocks, which, in the current environment and despite a dividend yield of almost 5%, do not, in our view, offer sufficient cash flow prospects.

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