Emma Wall: Hello and welcome to the Morningstar Series 'Why Should I Invest With You?'. I'm Emma Wall and I'm joined today by Mike Dellavedova, manager of the T. Rowe Price European High Yield Bond Fund.
Hi, Mike.
Mike Dellavedova: Hi, Emma. How are you?
Wall: Good thank you. Thought we'd start with oil prices. They are affecting everything and everyone at the moment, but in particular there are concerns about high yield, because it makes up a large part of the sort of global high yield universe, energy bonds, don’t they?
Dellavedova: Exactly, especially in the U.S. market. The U.S. high yield market really was a key funding source for a lot of the U.S. oil companies who were focused on fracking and horizontal drilling and that was a real game changer that we saw in the market.
If you go back a couple of years, no one would have thought oil would have broken south of $30 a barrel as it has done recently. It really does change the profitability and the cash flow and the cost dynamics that a lot of those U.S. high yield issuers are now facing.
Wall: I suppose leading on to that a lot of people are saying there are indicators in the high yield markets which suggest that we're in, we're about to experience global recession, what do you say to those scaremongers.
Dellavedova: I think there is a valid point there. But I think people have to be very careful on where they are looking and what part of the market. The U.S. corporate market has seen probably indications more of a profit type recession as opposed to a general economic demise. A big part of that has been what people are looking for on the outlook for example of default rates.
A big portion of that are likely to come from some of the energy, some of the oil companies in the high yield world in the U.S. that issued bonds in the past three to four years. Expectations are default rates or forced exchange rates could run as high or higher than 50% of that segment of the market.
Wall: Of course that is affecting the U.S. and this is European fund. I suppose the question is do you have contagion risk in market like this.
Dellavedova: I think a lot of where the markets trade on contagion risk actually represents an opportunity. At the end of the day I think something gets lost in the mix, lost in scaremongering of the negative headlines is high yield is fundamentally a credit market. And to the mid-long-term credit fundamentals will dominate. So potentially especially in European market, investors are concerned. There is a read across.
A big part of that is just the flow of capital. We're seeing the U.S. market has seen outflows almost of last year. So people do get nervous. But if people then dig a bit deeper and think what's really going to drive it. Why this company is different? What are the key drivers of their P&L, their cash flow generation. In a number of chances and it's an opportunity, things do standout as mispriced and it does represent a decent time for investors to take advantage of some of those opportunities.
Wall: Another thing that’s going to affect the European high yield market is the possibility that ECB will lower rates. We had Japan lowering rates into negative territory last week which sort of opens the door of the ECB to do the same and more. How will that affect high yield investors.
Dellavedova: I actually think it more than opens the door.
Wall: Pushes them through.
Dellavedova: Precisely they are leaping through both feet potentially. We do expect in March there will be further support from announcement of the ECB. Big part of that is tied in with investor and consumer concern. Decent part of the growth relatively small growth is being witnessed in Europe is driven by the consumer and consumer confidence as opposed to industrial spend. I think once that starts, you get rattled. Once consumer start to keep a closer hold of their wallets and purses and then potentially it does put a lot of pressure on the ECB to act and to show even more support and more quantitative easing.
Wall: I suppose bearing in mind everything we've just said this plays into the hands of sort of active bond pickers. This is a time for you to sort the wheat from chaff and work out what's going to be negatively affected by contagion and what is actually junks junk.
Dellavedova: I completely agree. It really is, it’s a time to really understand, appreciate and be able to price the risks that you are willing to take for investors. Look if you don’t right now you are actually doing them big service. But there is also the other side of that coin which means exactly that. If you are willing to do that opportunities do stand out and they can stand out for mid-to-long term really good value appreciation for investors right now.
Wall: Mike thank you very much.
Dellavedova: You are more than welcome.
Wall: This is Emma Wall from Morningstar. Thank you for watching.
