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Bonds worth backing? Six sovereigns under scrutiny
by Max Skjönsberg on Dec 18, 2013 at 15:59
Bond managers predict which of six eurozone nations could be worth investing in next year and which will be best avoided as debt troubles prove difficult to budge.
Baulk or back?
Fixed income managers are divided about the outlook for sovereign bonds in the eurozone. The region has emerged from recession, returning to positive GDP growth, but considerable problems remain.
‘We are in the midst of a small cyclical upswing but it is difficult to achieve any meaningful level of growth,’ said Citywire A-rated Gareth Isaac, who runs several bond funds at Schroders.
But Citywire A-rated Michael Leithead of EFG Asset Management was more upbeat. ‘Things have been pretty positive for the peripheral countries and you have seen the likes of Italian and Spanish spreads [over German bunds] come down quite a bit,’ he said.
We picked six eurozone nations, and asked bond managers for their opinion on each...click through to reveal what they said.
France: no stomach for reform
France’s credit rating was recently downgraded by Standard Poor’s, and some fund managers are concerned about the country’s unwillingness to undertake structural reforms.
‘The structural changes that Portugal and Spain have made have not been made in France,’ said Isaac.
‘In terms of liberating the labour market, significant strides could be made.
‘The new president has lowered the pension age, which is arguably unsustainable as we are living longer.’
Nevertheless, French debt is the largest allocation, at 20%, in Isaac’s €856 million (£530 million) Schroder ISF Euro Bond fund.
‘We prefer France to Germany, which is not yielding a great deal,’ he said.
Leithead, manager of the $257 million (£160 million) New Capital Total Return Bond fund, agreed France had done too little to shake up its economy but said he expected French yields to remain stable for now.
‘Further out, I think French debt could be a weak credit but not for the next three or four months,’ he said.
Germany: the safe haven
Citywire + rated Michael Krautzberger said German bunds had a place in portfolios even though the multi-decade bull market in Western government bonds could be over.
Krautzberger, manager of the €2.33 billion BlackRock Global Funds Euro Bond and the €3.6 billion Euro Short Duration Bond funds, said: ‘If it was a 30-year bull market in the sense that yields went lower and lower then it might be the end of a bull run, but I would not be surprised if you made more money from bunds than money markets in the next few years.
‘We are currently underweight but we will definitely continue to invest in them. They are very liquid.’
After an election in Germany earlier this autumn produced no outright winner, Angela Merkel of the centre-right Christian Democratic Union is seeking to form a coalition with the Social Democrats.
‘Germany has taken a turn to the left and may be undoing some of its reforms,’ said Krautzberger. ‘But that could be good news for the periphery in the long term because Germany has become too competitive relative to those countries, and that has been part of the problem.’
Italy: high political risk
Italy is one of the richest countries in the world and a member of the G8, but its high level of sovereign debt, low growth and recent political instability have placed it at the centre of concerns.
But Isaac places Italy in a different category to the other PIIGS (Portugal, Italy, Ireland, Greece and Spain).
‘Italy has a lot of private wealth, and it should for many reasons be considered as separate to the likes of Portugal and Spain,’ he said. ‘It is a more mature market and the debt is less of an issue because the population can finance it. On the other hand, growth rates are low and the demographic picture is poor.’
Krautzberger said Italy carried considerable political risk. ‘I’m not totally negative on Italy but there is still heightened political risk since it is not yet clear how long the government will survive,’ he said.
‘Italy also had a very high starting point in terms of debt level to GDP, and debt to GDP is still going up.’
Spain: in the downgrade zone
Isaac warned that Spain is in the danger zone of being downgraded. ‘It needs higher inflation and higher growth, and at the moment we see deflation and low growth, which is a dangerous recipe.’
According to Isaac, the Spanish people have paid a high price for the progress that has been made. He said: ‘Spain is improving and it is now starting to see the benefits of the changes it has made. But this has come at a very high cost for the population, and unemployment is over 25% and youth unemployment is over 50%.
‘A lot of Spanish graduates are moving abroad to the UK, the US and Germany, and that is going to be a factor when the economy starts to improve because it will be harder to innovate.’
Krautzberger is more confident that Spain is on the right track. He said: ‘Spain is now getting more competitive, so I am quite confident that it is moving in the right direction.’
Greece: outlook improves
The Greek economy has been shrinking for six years on the trot and is expected to continue shrinking in 2013. Nevertheless, some bond managers think most of the pain is past and the outlook has improved.
Leithead increased his exposure to Greek debt before the country’s debt restructuring at the start of 2012.
‘We had a little bit of Greek debt before it went into the private sector involvement [initiative], but we doubled the position in the New Capital Total Return Bond fund to 1%,’ he said.
‘It is one of our biggest contributors to performance this year. The yield was at around 27% when we bought it and it is now 9%. It has been a combination of running yield and capital appreciation.’
Krautzberger said: ‘There were points when we were invested in Greece in the past but we haven’t been active there for a while, mainly due to rating restrictions. But if a retail investor said he made a punt on Greek debt, he is more likely than not to make money from it.
‘The risk/reward ratio is not so good for conservative investors, however, because the situation is still unclear.’
Portugal: spreads may widen
Portugal’s finance minister resigned earlier this year after faltering public support for austerity measures. Leithead now regards the country as carrying the most sovereign risk in the eurozone.
‘There is momentum behind the programme in Greece, whereas I think Portugal will be a bit trickier over the next year or so,’ he said.
Yields on Portuguese 10-year government bonds have fallen from around 8.5% to 6% in the past 12 months. Leithead said: ‘Portuguese spreads are still quite wide and if you believe there will not be any hiccups in terms of extending the programmes, they are probably quite attractive.
‘But I can foresee some political risks coming up that could force the spreads wider.
‘Portugal did not cover itself in glory after the Cyprus crisis but it has kept to the programme well. If you see a spike there, it could create an interesting situation.’