German bunds 'no longer a safe haven'

Fund managers are avoiding German government bonds despite panic over peripheral nations sending investors running to the perceived safety of the eurozone’s largest debt market.

The move to shun bunds comes after a chaotic week which saw yields on the bonds of core European countries, including Spain and Italy, hit record levels.

Spreads on European debt over bunds also widened to euro-era highs. The ECB is now expected to act imminently by buying up debt, with investors warning of a meltdown in confidence.

German yields jumped briefly following comments from the country’s chancellor, Angela Merkel, that Germany was ready to cede some of its sovereignty to save the eurozone.

However, the rally was short lived and bund yields remain near record lows, with ten-year bunds paying 1.89% last Friday.

Signs the market is also becoming concerned German bunds are over-priced were seen in the CDS market. The cost of insuring against a default – while still low –climbed 25% in the last three weeks.

Against this backdrop, leading bond fund managers are warning investors to steer clear of bunds after the surge in price, warning they are no longer a safe haven and much better value is to be found elsewhere.

David Roberts, manager of Kames Capital’s £477m Strategic Bond and £197m Global Strategic Bond funds, said: “Believing that a 1.7% per annum return for owning ten-year bunds is the best risk-free option is wrong, when the investment is subject either to the uncertainty created by a eurozone break up, or the cost of holding the system together.

“It is not difficult to find better value and arguably better downside protection, just not within the eurozone.”

Roberts, who was short five-year bunds in the Global fund until the dips in price last week, said he would look to re-set this position on any strength in bunds.

John Pattullo, manager of the £1.1bn Henderson Strategic Bond fund, is also avoiding German government bonds in his portfolio.

He said given the normal yield on ten-year bunds was around 3%, with yields hitting a low of 1.64% recently, holders should consider selling.

He said: “Selling them now is perhaps not the daftest strategy. They are over-extended and they have been for a long time. So is there value in them – no. But do people want to buy them – yes.”

F&C Thames River bond duo Peter Geikie-Cobb and Paul Thursby have been shorting German bunds for the last six weeks.

Geikie-Cobb, co-manager of the group’s £930m Sterling Global Bond fund, said: “The bond market has reached the counterpoint of contagion and Germany can no longer be regarded as a safe haven as it is certain the German deficit will deteriorate if the ECB does not step in to support the market.

“The shorts reflect our view that all bond markets, with the exception of Japan, are hideously overvalued and for me to take off the shorts the yields on bunds will have to correct to between 3.5%-4%.”

Managers are expecting the European Central Bank to use the “bazooka” option in the next few weeks to prevent a disaster taking place in bond markets.

Pattullo said fears about being perceived as “soft” had so far prevented the ECB from acting as aggressively as the Treasury or the US Federal Reserve, but he expected a move “before Christmas” to support bond markets.

“We sense the ECB is close to the bazooka option, but it is obsessed with not being seen as soft,” he said.

“We think this could come to a head much sooner than anyone anticipated, and we think the ECB will come in and support markets, as the danger now is no one wants to buy Italian or Spanish bonds.”

Instead of bunds, managers are holding treasuries and gilts, both yielding more than bunds at present, as well as overseas debt.

Pattullo has his highest level in cash since 2008, with 20% of the fund in cash or short-dated gilts, while Roberts is investing in overseas bonds.

Roberts said: “The obvious place for euro investors is either gilts or treasuries. The

former does trade cheap relative to bunds (10-year gilts were paying 2.21% on Friday), while the latter is also a little better value, paying 1.98%.

“However, in the Global fund we have less than 4% across the US and UK. Instead of taking those easy options we prefer the benefits of diversification offered by Sweden, Canada and Australia.

“Sweden does offer less yield than Germany, but for those following European politics the benefit of owning something non euro related is hopefully obvious.

“In terms of Australia  and Canada, they are simply too cheap, with AAA-rated Australia paying double the yield of Germany.”