Morningstar's "Perspectives" series features investment insights from third-party contributors. Here, Hermes Fraser Lundie, Co-head of Credit, and Andrey Kuznetsov, Senior Credit Analyst, explore the opportunities provided by reverse Yankees.
Yankee bonds, which are issued in the US by a foreign government or company, have been a mainstay of the US fixed-income market for several decades. But in recent years, an increasing number of American companies have been doing the reverse: issuing debt in Europe. As a result, the so-called reverse Yankee market has already reached €330 billion and is primed for further growth driven by proposed changes to US tax law.
The Trump administration has made clear its aim to change the regulatory landscape for businesses, and if the rumoured end to the tax-deductibility of interest expense on debt becomes reality, it would likely lead to further expansion of the reverse-Yankee market. Why? American firms would be incentivised to issue bonds offshore in much the same way that many currently try to book profits overseas, in order to minimise the tax burden on their onshore profits.
There are also three further growth drivers for the reverse-Yankee market: Globalisation and currency volatility are compelling many US companies to find new ways of better matching their revenue streams with costs, and issuing euro-denominated debt is one way of helping them to do so.
The US dollar has risen against the euro by more than 20% in the past three years, making European companies attractive takeover targets for US firms. Funding at least part of such acquisitions in euros has been the preferred route for many companies.
The Corporate Sector Purchase Programme, the European Central Bank’s initiative to buy European corporate bonds in an effort to boost the eurozone economy, combined with Europe being at an earlier stage of the monetary-easing cycle than the US, has in some cases made it cheaper for US companies to issue bonds in Europe than in their home market. This is due to the lower-rate environment and the strong performance of European credit markets, which has driven yields lower.
Advantages for Investors
What does all this mean for investors? For those with the flexibility to allocate to reverse Yankees, the bonds provide a number of benefits. For example, they have considerably increased the breadth of the European credit universe, particularly for investors unable to allocate to bonds not denominated in euros. More choice means more opportunity to outperform.
The reverse-Yankee market also provides access to US companies that, in many cases, demonstrate higher credit quality than their counterparts in Europe. And it provides an excellent source of portfolio diversification as US and European companies are often subject to different performance dynamics.
Perhaps the greatest benefit is that the market is home to some excellent mispricing opportunities for global investors to exploit. Relatively poorly known US firms issuing bonds in Europe are, in some cases, compelled to price new issues with an attractive spread in order to attract European investors who are unfamiliar with their businesses. Such issuers may be just as creditworthy as a similar European company whose bonds provide a significantly lower spread. For investors with an in-depth knowledge of US corporate bond issuers, they represent an excellent opportunity to boost risk-adjusted returns.
Marching On
Reverse Yankees are established in the European credit market and should grow in importance. With Trump’s proposed tax changes and Europe at an earlier stage of its monetary-easing cycle than the US, American firms are incentivised to keep issuing bonds in Europe. As the market grows, investors with an astute knowledge of US corporate issuers and the ability to allocate to these bonds should continue to uncover attractive opportunities.
Disclaimer
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