S&P analyst Kate Hollis talks to European fixed income managers about how they have been adjusting their funds in response to events in Greece
The recent events in Greece have led to significant moves in eurozone government and other European bond markets since we last reviewed the sector in the fourth quarter of 2009.
In response to the unfolding debt crisis, we interviewed a number of European fixed income fund managers at the beginning of May to discuss how they have been adjusting their portfolios.
The restructuring story
Most managers we spoke with expect Greece will have to restructure its debt in the future, but doubt this will happen this year.
Michael Krautzberger, head of European fixed income at BlackRock, points out about 20% of the BarCap Euro Aggregate index is linked to Greece or countries that may be susceptible to contagion.
He believes the standard market indices will continue to include Greece as long as no other credit rating agency downgrades it to junk, which he does not expect to happen this year.
However, he believes some insurance companies or pension funds have already been under pressure to reduce positions since S&P cut Greece’s rating below investment grade.
Krautzberger believes the ECB will continue to accept Greek bonds as collateral. European banks, which are substantial holders of Greek bonds, could cope with a Greek debt restructuring involving a haircut of up to 25%, but this would accelerate contagion in other weaker eurozone governments.
However, he does not expect an immediate restructuring.
Joerg Warncke at Union told us any Greek restructuring would be more likely to extend debt maturities than impose a haircut (a reduction in the nominal amount of debt. For example, a bond that was issued to raise e100m will only repay e75m at maturity), as a formal default would be too political.
Raphael Robelin from BlueBay concurs, adding he expects any restructuring to avoid haircuts, as these would trigger CDS default clauses, while maturity extensions would not.
Both are concerned Greece’s deficit reduction plan is not sustainable and restructuring will be inevitable when this becomes clear in a year or two.
Johnny Debuysscher at Petercam expects the ECB will do what it has to do to keep the eurozone intact, even if that includes quantitative easing.
He also expects the ECB to buy government bonds at some point in the future.
Portfolio adjustments
Krautzberger is overweight Greece, but underweight the periphery overall. He preferred to buy the sovereign credit at a large discount to par than own Greek banks, and is also underweight peripheral financials.
He took advantage of the recent price falls to buy some short-dated Greek bonds.
The teams at Union have been reducing positions in Greek bonds since the beginning of December 2009. The funds are overweight in nominal terms, but underweight in contribution to duration, with few bonds with longer than three years to maturity.
Petercam also cut the overweight to Greece in Q1 and shortened up. The team switched into Iberian names but remains underweight overall.
BlueBay’s emerging markets debt team has been reviewing peripheral government credits on Robelin’s behalf and he has had no exposure to Greece for some time. He also sold his positions in Ireland and Portugal and went underweight Italy and Spain in February as a result.
Impact on currency
All the managers we interviewed were concerned about the long-term prospects for the euro, but all agreed being short euros is a very crowded trade.
Krautzberger believes the euro will underperform the Swiss franc and Scandinavian currencies, but is slightly less short than he has been.
Warnke agrees and adds the euro should outperform CEE currencies, which are a high-beta play on European growth, unless the euro falls so substantially against the dollar that eurozone growth increases more than they expect.
At Petercam, Debuysscher feels a recalibration of the euro against other global currencies will help European growth and there will not be a double-dip recession.
He believes 10-year bund yields will reach 4% in the very long term, but there will be plenty of trading opportunities in the meantime.
Robelin has also been looking for growth to surprise on the upside and has been slightly short duration this year as a result.
Impact on corporate credit
Bank credits have been under the spotlight again. Stephan Ertz at Union points out weaker banks, particularly in Germany, tend to have a higher proportion of peripheral government debt.
Union has no Greek or Portuguese banks and no Spanish caja bonds. Krautzberger is neutral on financials overall, but underweight peripheral banks.
Petercam is overweight banks overall, but has been underweight senior paper and overweight subordinated debt.
BlueBay is still avoiding senior paper, as Robelin expects new Basle regulations to lead to significantly more issuance.
Several managers mentioned utilities and telecoms have been widening, as these tend to have large financing needs. Ertz also thinks utilities might be subject to special tax levies from their respective governments.
However, the managers feel investment-grade bonds from the right issuers will continue to perform well.
Most managers have been avoiding taking very large positions anywhere in their portfolios, partly because volatility has been high and liquidity slipping, but also because the political outlook is so unclear.
Krautzberger has cut his funds’ tracking errors to about half last year’s level as he feels there is a high degree of systemic risk in the market and therefore a potentially high level of correlation.
Kate Hollis, senior fund analyst, S&P Fund Services
