September 9, 2016 / 2:52 PM / a year ago

Yield-starved investors find solace in sterling

LONDON, Sept 9 (IFR) - Corporate and financial issuers that had shunned the sterling market for most of 2016 are returning in droves, spurred by investors’ search for yield and the Bank of England’s upcoming corporate purchase programme.

Six issuers raised £2.4bn on around £6.7bn of demand this week as the fightback staged by the market since the UK voted to leave the EU gathers steam ahead of the start of the BoE’s purchase scheme later this month.

Investors forced out of the euro market by the tightening of yields caused by the ECB’s bond purchase programme are now turning to sterling, lured by the relatively attractive yields on offer. High cash balances have also contributed to the market’s renewed vigour.

“The sterling market, particularly the longer part of the curve, hasn’t competed with euros, whether it was on price or demand, for a good part of 2016,” said Sean Taor, head of European DCM at RBC Capital Markets.

“However, investors have been very active in sterling recently, which in turn has driven yields down and in many cases sterling is now more competitive than euros.”

Aviva, the UK’s largest insurer, attracted over £2.3bn of demand for a £400m 4.375% 2049 non-call 2029 Tier 2 bond this week, while British American Tobacco garnered £1.5bn of interest for a £650m 2052 benchmark.

BAT was also quick to take advantage of the US dollar market and returned the following day to print a US$650m three-year trade at a coupon of 1.625%.

“The announcement of the [BoE’s bond buying] programme has repriced the market and created demand from asset managers who felt they were underinvested,” said Zoso Davies, a credit strategist at Barclays.

“We were negative on the economic value of the programme but, with hindsight, it has unlocked the market and given it a new spurt of life.”

Bank of Nova Scotia, Paragon, Henkel and WPP were the other issuers to join the sterling party this week. Henkel attracted £1.4bn of demand for a £300m 0.875% September 2022 trade, while WPP drew £800m in orders for a £400m 2.875% September 2046.

“Corporate sterling bonds are attractive compared to the underlying Gilt yields which are at very subdued levels, and this may push investors further down the risk and tenor spectrum to source yield,” said Eric Holt, a senior fund manager at Royal London Asset Management.

“We have seen consistent inflows into our sterling credit funds and a noticeable increase in the more recent period.”

GOING INTERNATIONAL

This lease of life comes from a combination of domestic and international demand. While the former investor base can sometimes buy more than 90% of a sterling bond, international investors are now muscling in on the market.

Less than 50% of Aviva’s trade was sold domestically, for instance, while 35% of Bank of Nova Scotia’s 0.75% £500m five-year covered bond was placed internationally.

“There has been a lot of interest from overseas investors looking to take advantage of a depreciated sterling to purchase more corporate debt,” said Paola Binns, a senior fund manager at Royal London Asset Management.

“Despite the overhanging political risk regarding Brexit, returns still look attractive.”

According to RBC’s Taor, many investors are changing their mandates so that they can invest in sterling.

The universe of sterling investment-grade bonds trading at a negative yield stood at 0.16% on September 9, according to Tradeweb, far less than the 31.82% in euros.

NOT SO FAST

While demand is clearly there and issuance has been vibrant since the Brexit vote, the market has to digest Mark Carney’s statement in front of the Treasury Select Committee this week. The BoE governor suggested that the universe of bonds targeted by the bank’s programme might be smaller than expected at £100bn (rather than the £150bn analysts expected).

“It now sounds as if the programme will arrive later and be more selective than expected, so we will probably have a few sessions of uncertainty as people reassess their expectations. Some bonds will need to reprice wider,” said Barclays’ Davies.

The BoE has said that it would buy up to £10bn of corporate bonds as part of its quantitative easing programme but it is still grappling with what should make the cut as the “criteria of material contribution to economic activity in the UK” proves tricky to define.

“Our interpretation of this is that the BoE may end up sticking quite heavily to the blueprint of their 2009 corporate bond purchase scheme,” Bank of America analysts said in a research note. (Reporting by Helene Durand, Laura Benitez, Editing by Matthew Davies, Ian Edmonsson)

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