Nordic cross-over

Dating all the way back to the 18^th century, the Danish covered bond market has a rich history and can still boast of having one of the largest and most active markets in Europe. At the same time Norway has a strong tradition when it comes to corporate bonds and high yield issues.

Nordic fixed income total market volume development by issue category since Jan 2008 in NOK billion:

Digging into this regional market, we find that the investment grade and high yield bonds combined amount to approximately 1800 bln EUR in total. As can be seen in the chart above, this market has experienced a strong growth over the last 10-15 years. As mentioned, covered bonds have a long and strong history in the Nordic region and still make up around 50% of the total market. Government bonds, municipalities and other government guaranteed issuers account for another 18 % of outstanding bonds in the universe.

By excluding covered and government/government-related bonds from our dataset we get an estimate of the corporate and financial credit universe. On this measure, we find that the Nordic corporate and financial market is around 600 bn EUR all in all.

Market distribution by issue type:

Source: Stamdata, Swedbank Credit Research, DNB Asset Management (further analysis)

Behind the headline figures several interesting developments have taken place. Interaction between markets and currencies has increased as investors and issuers alike have become more active across the borders. Further, the high yield market has grown from being a predominantly Norwegian marketplace concentrated around industries like oil services and shipping some 10 years ago, to a truly pan-Nordic market which has quintupled in size.

The intersection

In the intersection between Investment grade and high yield we find the crossover segment. A strict definition of crossover credit is a situation where a bond is speculative grade but very close to investment grade or vice versa. Hence, we are looking at the lower segments of investment grade and the strongest segments of high yield. For many investors and market participants there is a rather sharp line drawn in the sand between IG and HY. Consequently, this segment of the market offers an interesting dynamic in which more flexible investors may discover attractive opportunities.

In this small case study, we apply a somewhat broader definition of the crossover segment. We look at corporate and financial issuers in the BBB flat to BB flat area, either explicitly rated or of equivalent credit quality. Consequently, we include both rated and unrated issuers and issues, and we also include subordinated bonds from banks and insurance companies.

Using this set of criteria, we end up with an estimate of the market segment. The charts below outline the composition of the market. Currently, we estimate the outstanding amount of these bonds to approximately 170 bn EUR. Financial companies account for ~1/3 of this, consisting mostly of subordinated bonds, whereas non-financial companies constitute the rest.

A diversified sector composition

Among non-financial issuers we find a diversified sector composition. Real estate is the largest sector, followed by Utilities, Telecom, Industry and Autos. The different countries in the Nordics contribute with a strong footprint in different areas of the non-financial segment, securing a broad sector composition.

Non-financial companies sector composition:

Source: Stamdata, Swedbank Credit Research, DNB Asset Management (further analysis)

For investors looking for a decent yield but not willing to explore the more speculative parts of the high yield market, the lower segments of investment grade and the stronger parts of the high yield market provide an alternative approach to fixed income allocation. The combination may provide better yield characteristics than a pure investment grade portfolio, and at the same time offer lower volatility in returns than a pure high yield portfolio. Together this may be a good trade-off between risk and return for investors seeking for yield in an environment characterized by low rates across developed markets.

To sum up, the crossover segment of the Nordic bond market provides interesting opportunities for investors. The segment is quite large, diversified, in a highly stable region of the world and offers attractive investment opportunities for investors looking for exposure between pure IG and HY markets.

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