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Brexit Premium Still Abundantly Available

16 May 2017 by Mark Holman

Having spent the last week in the US, where local investors can be quite domestically focussed (primarily due to this being the largest fixed income market in the world), one of the main discussion topics was global relative value.

To us it seems natural that the most advanced economy, and also the quickest of the developed economies to recover from the global financial crisis, was also most likely to have the least value from a fixed income perspective. Hence, a discussion on global relative value was both interesting and welcomed by everyone we met.

Despite the UK market being significantly smaller than the US market, the investors over there were particularly interested to hear what was happening with our ‘little divorce’ from Europe and the impact that this will have on our fixed income market. We did comment the day that Article 50 was triggered, why investors should not be afraid of UK exposure in this blog : TwentyFour- Article 50 Triggered, but a lot has happened since then; so we thought it worthwhile revisiting whether the ‘Brexit Premium’ is still there to be had.
A brief comparison between US and UK high yield should suffice for illustrative purposes.

Sources: BAML, Bloomberg

As the table shows, from an index standpoint, the UK market offers an additional 41bps over the risk free, it is ¾ of a year shorter and a notch better in overall rating. In terms of defaults, the US market does still include the painful, although now recovering sectors of energy metals and mining, but we would still expect the UK default rate to be significantly lower than that in the US. For a like for like risk we equate this to being close to 100bps of pick-up in the UK, so research in this geography is potentially well rewarded.

Will our ‘divorce’ change that? We do not think so, maybe at the margin it will lead to selected downgrades, but overall we expect that Brexit will be much more of an earnings issue (i.e. an equity problem) rather than a solvency one. So the enhanced returns that we have seen year to date should continue, especially when we consider the additional circa 100bps that are also gained by swapping £ into $.

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