European Credit: An Underrepresented Market with Outsized Potential

Introduction

European credit has historically had a modest presence in global credit benchmarks, resulting in reduced allocation in most global portfolios. In contrast, more than 60% of global indices are weighted towards US credit, though we do not believe this is always where the best opportunities present. Indeed, we think Europe has several attractive characteristics relative to its US peers that warrant greater attention from investors. We explore several of them in this article and explain why they present an opportunity to active managers.

#1 Europe has a developing corporate and lending market

European companies rely less on bond markets compared to their US counterparts. The volume of European corporate bonds has steadily grown (the total now sits at €3.5 trillion)¹, and Europe's share in total credit has increased, albeit from a low level.

Why is this the case? While progress is being made, Europe continues to be hampered by an over-reliance on the banking system and the enduring fragmented and complex nature of its markets. France is most active in the bond market while Germany has the lowest share of corporate bonds (6% of GDP)² compared to other large European countries. This fragmentation presents opportunities for active managers who can capitalise on the resulting market inefficiencies.

Figure 1. Europe: A fragmented and complex market

Source: OECD and Deutsche Bank Research, as of 31 December 2023.

#2 Europe’s patchwork quilt of bankruptcy regimes creates inefficiencies

Sticking with the theme of fragmentation, not only do bankruptcy regimes across Europe vary, but they also have limited legal precedent. This lack of commonality creates more complexity, but it can also lead to structural inefficiencies. Ultimately, this creates opportunities for investors who understand the nuances of the region and key stakeholders to drive better returns through restructuring.

The lack of precedent also creates a more significant return opportunity compared to the US. The US has a well-established framework, Chapter 11, built on decades of legal precedent. Chapter 11 offers a way to restructure an entire corporate group operating in multiple jurisdictions, there is no equivalent single process to restructure a group in Europe.

#3 Fiscal policy pivot likely to support European corporate earnings

Earlier this year, Germany announced its planned increase in defence and infrastructure spending. It marks a pivotal shift for Europe and the largest economic stimulus since the fall of the Berlin Wall. After years of lagging US growth, Europe may find new momentum through its largest economy’s fiscal expansion. Although high debt levels constrain similar spending in the UK, France and Italy, we expect this German fiscal stimulus to provide meaningful support for European corporate earnings.

#4 European fundamentals are superior to US peers

European companies tend to have more conservative balance sheets than their US peers and this is backed up by leverage data and interest coverage ratios, as shown in Figure 2. The European Central Bank is ahead of the Federal Reserve in terms of interest rate cuts and this should also help to alleviate some of the interest cost burden for companies looking to refinance.

Figure 2. European high yield interest coverage ratios have typically been higher than US counterparts

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Source: ICE BofA. Shows long-term average based on data from 2 April 2011 to 31 May 2025.

This is also borne out in their higher ratings versus US peers, as shown in Figure 3.

Figure 3. Better fundamentals also reflected in higher quality ratings

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Source: ICE BofA, as of 30 April 2025.

In addition, the US is slightly more tilted to cyclicals at around 70% compared to approximately 60% in Europe,³ which suggests European credit could perform better in a slowdown.

#5 European companies’ public market participation is lower

Public companies are far more prevalent in US high-yield markets, representing 52% of issuers, while only 24% of European high-yield issuers are public.⁴ Europe's lower public market presence reflects the prevalence of privately-owned, and in many cases family-owned, businesses in the region.

While lower public market participation poses challenges in terms of information access and data transparency, it also creates an opportunity for investors with the expertise to perform rigorous credit analysis and due diligence, as well as those who have built strong relationships as long-term lenders. These relationships can lead to more attractive allocations in primary markets or more constructive pathways to resolve refinancing needs.

#6 Valuations in Europe are more attractive

For much of the period from 2018 to today, European high-yield credit has traded at a wider spread than the US (Figure 4). This persistent premium reflects several structural factors, some of which we have already discussed: Europe's less liquid market, smaller issue sizes and more complex multi-jurisdiction framework. Additionally, the region's lower economic growth rates and political uncertainties have contributed to higher risk premiums. While some of this spread premium compensates for genuine risks, we believe it often exceeds what fundamentals would justify, particularly given European issuers' typically more conservative balance sheets and historically lower default rates.

Figure 4: Difference in US versus European high-yield option-adjusted spread (bps)

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Source: Bloomberg, ICE BofA, as of 22 May 2025.

The comparison is even more stark when looking at CCC rated credit, as shown in Figure 5.

Figure 5: Difference in US versus European high-yield option-adjusted spread (bps)

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Source: Bloomberg, ICE BofA as of 22 May 2025.

Figure 6 compares European and US credit inter-decile spreads, highlighting wider dispersion in Europe and suggesting greater potential for active managers particularly in small and medium sized issuers.

Figure 6: Europe offers a fertile ground for active management

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Source: Man Group database, ICE BofA, as of 30 April 2025.

#7 Europe is facing a more acute maturity wall relative to the US

While a more acute maturity wall may initially appear to be a negative, we see an attractive opportunity to capitalise on dislocations, with bonds likely to trade at deep discounts to par if the market believes that refinancing could be challenging. In addition, we foresee opportunities to partner with companies to help reprofile debt or to provide private solutions to help deal with upcoming refinancing.

Figure 7: Increased opportunity to participate in dislocations, distressed or capital solutions transactions

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Source: Morgan Stanley, as of 30 April 2025.

#8 Europe has a vibrant financials marketplace

In previous papers, we have highlighted the stark differences between the attractiveness of European and US banks. In addition, Europe benefits from a vibrant financials marketplace with issuance from covered bonds to Additional Tier 1 (AT1) bonds, which serve as contingent convertible capital instruments for banks. This creates attractive inter- and intra-capital structure opportunities for selective investors with the skills to do the deep research needed to capitalise on the most attractive opportunities and to avoid potential pitfalls. Additionally, larger players’ attempts to acquire smaller and medium-size banks has created a positive backdrop for spread compression opportunities, particularly as larger banks tend to have higher ratings and tighter credit spreads.

Conclusion: A compelling case for European credit

We believe that European credit presents an attractive proposition, supported by stronger fundamentals than US peers, as well as positive market momentum from Germany's fiscal policy pivot. While traditionally underrepresented in global portfolios, Europe's market inefficiencies, conservative capital structures and prevalence of family-owned businesses offer opportunities for active managers to pursue alpha that may be increasingly scarce in US credit markets.

1. Source: ICE BofA, as of 22 May 2025.
2. Source: Deutsche Bank, as of December 2024.
3. Source: Morgan Stanley, as of 30 April 2025.
4. Source: Morgan Stanley, as of 30 April 2025.