Playing the normalisation of European bank capital structures will continue to provide opportunities to earn high yield-like returns with lower risk for at least three years, according to Pimco.
The deleveraging of financial institutions is a key theme for the Californian-based asset manager, which launched its Pimco GIS Capital Securities fund last June and is lead managed by Philippe Bodereau.
Flavio Carpenzano, part of the management team on the fund, said it is running a barbell strategy that aims to exploit the pricing dislocation between’ senior and subordinated bank debt.
Speaking at the Wealth Manager Conference last week, Carpenzano said the team is blending bonds issued at the bottom end of the capital structure by the Continent’s strongest banks with the senior debt of weaker Mediterranean banks.
‘If you look at Cocos issued by Europe’s strongest banks, such as Barclays and Rabobank, they are yielding 6-7% and paying you a spread of four times their senior debt,’ Carpenzano said.
‘This is not sustainable and as the capital structure normalises, spreads will tighten and the prices will appreciate. In Spain we are seeing the normalisation of the banking system, driven by the upcoming European Central Bank stress tests and a stabilisation of the housing market.
‘We sit at the top of the capital structure in Spanish and Italian banks, but the bonds still offer attractive spreads of 100 basis points or so over Italian government bonds.
‘We expect the fund to return 6-8% this year. Even if you expect no capital appreciation, you get carry of 5-6% and we still think there are opportunities to get another 1-2% from the compression of capital structures.’
While this deleveraging and normalisation story has largely played out in the US, Carpenzano believes the theme will continue to provide opportunities for the ‘next three years’ in Europe before the team has to cast its net more globally.
He argues that the strategy is a viable substitute for high yield, providing comparable or higher returns but with a greater depth of liquidity.
‘When banks issue Cocos it is generally between £1-2 billion, compared to large high yield companies which generally issue £500-700 million,’ he said.
Since launch, the fund has returned 13.77% versus a 9.87% rise in the Barclays Global Capital Securities Banking T1/UT2 All USD hedged index.