The Daily Update - Teva RZD, yields spreads

The search for yield looks to continue spurred on by the ECB and the BOJ’s actions. Of course we are in a different situation from yester-year and we feel that is why so many investors were caught out by the move lower in yield curves and indeed the move to negative yields in so many countries and now are chasing yields lower.

We are always told “past performance is no guarantee of future performance” but so many draw conclusions from the past when the world is a different place and central banks are utilising strategies never seen before.

Our own thoughts are that yields will keep moving lower and that spreads that are not cheap by historical measures, are certainly not expensive if we look forward and extend the period of easy money from the central bankers into next year and even the year after.

However, we feel there are still opportunities in selective credits and spreads can contract back at least to those seen mid-2015. At that time we had the likes of Qatar 30’s trading around +130 basis points off US Treasuries, today they are at +176 bp and so still a way to go, 7 points in price just to get to last year’s level.

There is a rather unquenchable thirst for yield at the moment forcing yields and spreads lower as seen by some of the new issues of late. Last week pharmaceuticals company TEVA came to market with issuance of $15 billion in various tranches of various currencies, investors reportedly put in demand for $70 billion of bonds.

The ten year US dollar 3.5 billion tranche was issued at a spread of +160 bp and has rallied over a 1 ½ points since issuance, hardly surprising given the demand, but at +160 bp we calculated this issue as nearly two credit notches expensive for its BBB rating with “fair value” at around +222bp and so not much interest for our portfolio’s.

We prefer undervalued credits that offer us a spread cushion such as Russian Railways (RZD) which is rated by Fitch at BBB- and has Russian Government ownership. We hold their sterling issue, the 7.487% maturing in 2031 which yields 6%, a spread of +461 bp which is around three credit notches cheap given “fair value” would be a spread  of around +272 basis points, a move to that level is a rise in price of 23 points.

Broadly our portfolios have a yield spread of around 200 basis points over the government curves and have a weighted average credit quality of A3. As can be seen above our holdings, such as RZD, have to rally to obtain “fair value “ while the TEVA issue has to fall over 6 points to achieve its “fair value “.