Managers running European pension funds' liability driven-investing programs could have a challenge on their hands: The pool of euro-denominated, highly rated U.S. corporate bonds they've been buying over the past year might be about to dry up.
U.S. corporations issued more than $16.6 billion in euro-denominated AA and above-rated corporate debt in 2016, according to Thomson Reuters data, prompted by a strong dollar and a demand caused by the European Central Bank's asset purchase program, which is vacuuming up about €350 million ($368 million) per day.
U.S. corporate bonds tend to have longer maturities than do European equivalents, making them a good choice for LDI managers seeking to better match the duration and cash flow patterns of pension fund liabilities. By comparison, European corporate bonds usually on average rate in the BBB region and have shorter durations than higher quality U.S. corporate bonds.
These U.S. corporate bonds also have been higher yielding than European government bonds — something German and Dutch pension funds benefited from in particular, as their longer government bond yields languished in negative territory last year. Yields since have gradually risen and 10-year bunds traded at 0.42%, while 10-year Dutch bonds traded at 0.53% last week.
“Corporate bonds are used in our LDI strategies. Moreover, corporate bonds denominated in euros from U.S. issuers are significantly allocated in matching portfolios,” said Rene Penzler, co-head of multistrategy and pension solutions at Deutsche Asset Management in Frankfurt.
“Given the reduced liquidity in corporate bonds markets and the ECB asset purchase program, new issuance is an important source to add exposure in matching portfolios,” Mr. Penzler added.
BNP Paribas Investment Partners incorporated euro-denominated U.S. corporate bonds into client LDI portfolios last year, said Anton Wouters, head of customized and fiduciary solutions in Amsterdam.
However, analysts warn that euro-denominated U.S. corporate bond issuance is expected to decline this year, in part due to the ECB's plan to reduce the rate at which it will purchase assets after April.
In December, ECB President Mario Draghi announced the bank would trim the target monthly purchases — a decision interpreted by market participants as the beginning of the end of quantitative easing. In December, the ECB purchased only e4 billion, 39% less compared with average monthly purchases.
“At the moment, it is still interesting for U.S. corporations to issue in euros because of the low rates,'' said Mr. Wouters.
“The moment the rates will rise, this may change depending on where the rates are going to be in the U.S. and other regions, but I am not sure it is going to happen soon,” he said. “It depends on when the ECB will start the "real' tapering.”