Stockholm (HedgeNordic) – The search-for-yield behavior has been one of the major investment themes over the past decade. The Nordic high-yield market, which has transformed from a predominantly Norwegian marketplace dominated by industries such as oil services and shipping to a truly well-diversified pan-Nordic market, has been one source of extra yield for income-seeking investors.
“The Nordic high-yield market has grown considerably in size over the last ten years,” says Svein Aage Aanes (pictured), Head of Fixed Income at DNB Asset Management and portfolio manager of the asset manager’s high-yield strategy. “When we started our high-yield strategy back in 2012, the market had just over NOK 200 billion in loans outstanding,” points out Aanes. The market has grown to reach NOK 900 billion in loans outstanding, with the number of issuers growing from under 300 back in 2012 to about 700 today.
“We have also seen the market develop from a mainly Norwegian marketplace, where the main sectors used to be oil services and shipping, into a well-diversified market with substantially broader sector diversification,” says Aanes. “Sectors such as oil services and oil production, which used to be quite dominant sectors, would now account for below ten percent of the Nordic high-yield market.” Each of the Nordic countries contributes with a strong footprint in different areas of the non-financial Nordic high-yield market, facilitating broad sector diversification within the marketplace. “Among the main sectors in the market, you now will find real estate, technology, banking and consumer services, among others.”
“We have also seen the market develop from a mainly Norwegian marketplace, where the main sectors used to be oil services and shipping, into a well-diversified market with substantially broader sector diversification.”
“On the investor side, the Nordic high-yield market has also developed in a positive direction over the past ten years,” argues Aanes. When DNB’s €1.7 billion high-yield bond fund was launched back in 2012, the main investors in the Nordic high-yield market were mutual funds and some family offices, according to Aanes. “Although mutual funds still represent an important investor base, the market now also attracts insurance companies, pension funds, and quite a large presence from international hedge funds, which provide liquidity to the marketplace,” says DNB’s Head of Fixed Income. “The liquidity in the market has improved with the market growth and the widening of the investor base.”
Differences From the Global High-Yield Market
Although the Nordic high-yield market has evolved significantly and transitioned toward the more mature foreign markets, the marketplace exhibits some particular characteristics that differ from major European or U.S. high-yield markets. “One aspect is that quite a lot of the issuance in the local markets are in floating-rate note format, which implies that the duration in the market is quite short,” starts Svein Aage Aanes. “Another important aspect to be aware of is that transparency in the market might be a bit lower than in the major global markets, mainly because not all issuers have an official credit rating,” he continues. “A third aspect is that the average size of the issuer is somewhat smaller than you would observe in the larger international markets.”
“One aspect is that quite a lot of the issuance in the local markets are in floating-rate note format, which implies that the duration in the market is quite short.”
“As a compensation for these factors, you typically receive a somewhat higher credit premium in the Nordic high-yield market,” emphasizes Aanes. “At present, the difference would be to the tune of 200 basis points.” According to Aanes, this “spread pickup in the Nordic market is relatively attractive even after taking into account the lower coverage of ratings and the somewhat smaller issue sizes.” Looking ahead, DNB’s fixed-income team led by Aanes is “firmly convinced that the Nordic high-yield market will continue the development that we have seen over the last ten years,” says Aanes. “The market is going to continue to grow, the number of issuers is going to continue to grow and also sector diversification will continue to grow.”
Sustainability in the Nordic High-Yield Market
Sustainability has become a key issue and area of development in financial markets, and the Nordic high-yield market is no exception. “Sustainability and sustainability-related issues have become increasingly important in the financial markets over the past few years. This is a development that we have seen very clearly also in the Nordic high-yield market,” confirms Aanes. One indication of the increasing importance of sustainability in this marketplace is the issuance of green bonds. “If you look back to 2014, the outstanding volume of green bonds in the marketplace was around NOK 1 billion. As late as December of last year, this number was NOK 44 billion. And at present, the number is up to NOK 67 billion,” says Aanes. “The increase has been very strong and continues to accelerate.”
“Sustainability and sustainability-related issues have become increasingly important in the financial markets over the past few years. This is a development that we have seen very clearly also in the Nordic high-yield market.”
The issuance of green bonds is just one aspect of the sustainability wave, according to Aanes. “If you look at the access to sustainability information from companies, there has been a clear improvement in the market over the last few years,” says DNB’s Head of Fixed Income. “Presently, there is almost no new bond issuance where the company does not include sustainability information, information on their sustainability strategy and so on.” Even so, “there is still some work to be done,” emphasizes Aanes. “That particularly goes to the companies’ continuous reporting on sustainability, and particularly in hard data format, where you can get access to, for instance, climate gas emissions data and so on.”
DNB’s High-Yield Strategy
The team managing the DNB High Yield Fund relies on a bottom-up strategy to invest in the growing and continuously-diversifying Nordic high-yield market. “Our analysis starts with the individual company or the individual investment case. We will look at the financial information from the company and we will look at the business model and strategy,” explains Aanes. “When a company comes to the market looking to borrow, we will also typically meet the top management of the company to get an improved picture of their strategy and business plan,” he continues. “Based on the company’s specific information and the bond specific information, we will try to make up an opinion about the risk and the credit risk on this investment case. Lastly, we will try to decide what kind of compensation in the form of credit spread we would need to see to make this an interesting investment.”
An attractive investment in the high-yield bond market ideally involves a company with both the ability and willingness to repay debt, according to Aanes. This type of company usually has strong balance sheets, enjoys strong earnings potential and also exhibits high visibility in future earnings and cash flows. “Unfortunately, if a company ticks all those boxes, the credit spread would probably be quite low because the credit quality would be very high,” argues Aanes. “Often, when deciding on investments, you would have to make trade-offs in the high-yield market. We tend to be willing to trade somewhat higher transparency in future cash flows against somewhat weaker balance sheets.”
“Often, when deciding on investments, you would have to make trade-offs in the high-yield market. We tend to be willing to trade somewhat higher transparency in future cash flows against somewhat weaker balance sheets.”
The DNB High Yield Fund has generated an annualized return of 4.2 percent since its inception in 2012, more than double the 2.1 percent generated by its benchmark. “To be able to deliver a decent return over time, it is also important to have a tight risk control of the overall portfolio,” points out Aanes. His team’s risk management involves “a top-down overlay where we try to control for sector and factor risks,” according to DNB’s Head of Fixed Income. “We do not want the portfolio to be too exposed to individual sector or factor risks. Examples of that kind of risks could be the oil price, could be property prices but also other factors.”
“To be able to deliver a decent return over time, it is also important to have a tight risk control of the overall portfolio.”
“We also integrate sustainability and sustainability-related risks in our portfolio management,” elaborates Aanes. “This implies that in addition to looking at financial risks, we also look at risks stemming from a company’s sustainability strategy or lack thereof,” he continues. “We do this both through gathering data on individual companies, but also through looking at the sustainability-related information we receive from companies and entering into dialogue with companies and company management in bond investor meetings. As a major investor in the Nordic high-yield market, we have quite a lot of influence when it comes to discussing sustainability with companies.”
This article features in HedgeNordic’s 2021 “Alternative Fixed Income” publication.