The heavy hurt in European high yield: "Young people have never traded a real bear market"

Not so long ago, European high yield traders were in demand. UBS hired Robert Laux from Bank of America; Bank of America hired Gajern Kailavasan from Deutsche Bank and Barclays hired Justin Mullem from BofA. Jon Stead left Morgan Stanley for Jain Global in August. And even this week, BofA hired Tharsh Tharshan from Citi. 

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Insiders say many of the moves involved "high prices" and generous pay. But now the party may be coming to an end. European high yield is not what it was. 

As we reported earlier this week, Dan Cohen, the head of high yield at BNP Paribas, is no longer there. Neither Cohen nor BNP Paribas commented on his exit. Insiders say that various desks are down. Virgin Media O2's plummeting bonds are blamed.  

There is pain on the buyside too. FT reported yesterday that credit-focused hedge fund Arini Capital is down 7% this month, compounding its 15.7% loss between January and the end of September. Bloomberg reported that the Sona Master Fund lost about 3.1% in the first two weeks of October. Diameter's returns were negative in the same two week period, said Bloomberg. The three funds are some of the biggest in the European market. 

In a possibly unrelated move Bloomberg reported yesterday that Andy Silver, Brevan Howard's head of credit trading is leaving his frontline role and taking up a broader strategic and advisory position. Brevan Howard didn't comment for this article, but Bloomberg noted that when Silver joined in 2021, it was to expand Brevan's credit trading operations. David Abbou is taking over day-to-day running of the business; Brevan’s master fund was down 0.6% to September.

Speaking off the record, multiple traders in the European high yield market, on both the buy-side and the sell-side said the market has come unstuck. Senior traders have left the industry, liquidity has shrivelled and risks have risen. European high yield is not for the faint hearted, and there are fainter hearts all around. 

"The big buyers in the market have been hit and there are massive negatives everywhere," says one portfolio manager at a London hedge fund. "There's a lack of senior risk takers across the board and because PnL is lower in general, senior management no longer has the desire to run high yield vol and big books." This is creating gap risk. "There is no desire or ability on the street to take risk during periods of stress." Put simply, liquidity dries up. 

It's a far cry from 2019 when Arini's Hamza Lemssouguer made $120m in profits aged 29 while at Credit Suisse and then a reported $220m profit in the first quarter of 2020 aged 30. Lemssouguer's profits at Credit Suisse were reportedly made betting on the bonds of Thomas Cook, Rallye, Altice and Europcar.

When Lemssouguer left Credit Suisse six years ago, Citadel reportedly offered him a job. But market insiders say the big multistrategy firms are becoming increasingly wary of taking European high yield positions. Although Sona's Michael Boam quietly joined Millennium in March, the bigger funds are not thought to be the biggest players in the market. Insiders say the biggest players in the market are instead the likes of Arini, Sona and Diameter, who are hurting from recent losses.

With the big players smarting, there are fears that liquidity will dry up further, just as the Bloomberg index of spreads for Europe's lowest rated borrowers hits its highest level since early COVID. The losses do not all have equivalent causes, though. At Arini, the expected restructuring of bonds at Altice International, Brightspeed and Aston Martin is to blame. Arini has told clients the losses are part of its contrarian approach and that they don't reflect soured investments. At Sona, exposure to Virgin Media and Paramount Skydance turned profits negative.

One senior figure in the high yield market, who's worked in both banks and hedge funds, says the European market has broken. Corporates in Europe that issue high yield debt have increasingly begun using "dropdown strategies," he says. Bonds are secured on a defined group of companies rather than on specific assets. In a drop-down, the company moves valuable assets out of that defined group and into a new subsidiary. There, it borrows against them, leaving existing bondholders with much less collateral. "The covenants have become so weak on everything that as companies get into trouble, the companies can move security away from bondholders," he says. 

Both Altice and Aston Martin have made use of dropdowns and when they were deployed, their debt plummeted almost overnight. "When the most stable things become unstable no one wants to touch a bomb," says the senior high yield trader. "You can buy much safer stuff at higher yields."

Following the ejection of up to 100 people from London macro funds, many are predicting that European credit jobs will be next. Banks are likely to clear out loss-making desks; funds may pull back from the asset class. No one wants to be left holding a hot potato, says the trader. 

It means that a generation of traders who were in hot demand could find themselves out in the cold. "The last time there was a bear market in credit was nearly two decades ago during the financial crisis," says Matthias Schwarz, the former head of EMEA credit trading at Bank of America. "There's a big cohort of traders that have never traded an oversupplied market." Suddenly their services will not be needed. Traders who bought high yield assets from large and dominant clients simply to oblige the clients and stay in the game have been particularly burnt. 

There are, of course, other entities in the market. Citadel Securities has been talking about moving into high yield for a while and president Jim Esposito said this week that it's expanding in fixed income (although it's not clear whether European high yield is what he had in mind). Jane Street is a major player in flow high yield and is "crushing" the bid offer spread and making it even harder for banks' desks to make money, says one PM. It's not clear that electronic firms would want to hire OTC traders, though.

Schwarz suggests traders in the market are about to get an education and advises them to sit it out. "As an old guy who has done this for 25 years, I am telling you this is just the cycle," he says. "There's been a four year bull market in equities and a lot of liquidity has been extended to clients who should not have received it. The market will turn and you will have losses. This is what happens." 

The head of high yield trading at one bank confirms Schwarz's take. "Banks/funds that are currently long risk in the highest risk stressed credits are doing badly and will probably continue to," he says. "Going forward, though, the opportunity should be better than it was before the vol, as it should be when you get dispersion."  

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