Augustus Asset Managers’ funds are to invest more heavily in convertible bonds as it feels the equity risk premium is now higher than the premium it can earn on vanilla bonds.
Tim Haywood, investment director of Augustus, a fixed income-focused unit within GAM, says the manager will seek to reduce its long corporate bond exposure as it looks to benefit from future volatility while participating in higher equity prices.
He says: “We feel those buying corporate and high-yield bonds now could be too late. At present levels, the asset sub-class is quite expensive relative to our forecast of its future volatility. If I were forced to choose between credit and equity, I would prefer equities.
“I could imagine UK corporate bonds underperforming UK stocks, although I do not think either will show very high returns this year, and both could be quite volatile. Convertibles are long volatility and implied volatility is not yet expensive.”
He adds, “Now banks are heavily influenced, regulated, if not owned, by governments, and given their increasingly heavy ownership of government debt, their fortunes are even more inter-twined.
The credit spreads of both sovereign and bank debt within Portugal, Italy, Spain and Greece are equally reasonable, on a no-default basis.”
Analysis by Credit Suisse last month found of Greek debt; 30% is held by domestic banks, followed by 23% in the UK and Ireland, and 11% in France. But government debt makes up just 5% of the balance sheets of eurozone banks.
“If there is a sovereign default, or near-default, I forecast banks will be the worst affected because of their fractional funding. The greatest challenge is getting your sovereign analysis right.”
Haywood says a sovereign default would be “calamitous”, not least on banks holding government debt.
Haywood says one profitable trade at the moment is being long sovereign bonds, and selling protection – which hopefully will not be called upon – on bank debt.
