Kames: Germany cannot bail out Europe and keep AAA

Kames Capital's fixed income team has said quantitative easing in Europe is a must in order to prevent Germany losing its AAA rating.

Managers Phil Milburn and David Roberts - who run the group's Strategic Bond fund, among others - said QE in Europe was "absolutely essential", with Germany unlikely to keep writing cheques to bail out the periphery because of the threat to its AAA rating.

Roberts said: "Believing that Germany will be able to bail out Europe and retain a AAA rating is naive.

"We are seeing QE through the back door with liquidity for the banks and although it is not solving the crisis in the short-term it is a move to a more sensible fiscal program."

The duo also expect the UK to expand its own QE programme, predicting the Bank of England will announce an expansion to the £275bn QE program in the next four to five weeks.

The bond managers also delivered a warning to investors buying government debt, following the rush into safe havens which pushed prices up and yields down to record lows.

Roberts said out of 78 countries, two thirds have seen a rise in inflation over the past year despite the difficult economic conditions and pressure on the consumer, something which will hurt bond investors if it is maintained.

"Investors have been happy to ignore valuations and real returns to chase safe havens in the view it will get your capital back. But I think the positive numbers in the US have some legs, while global growth and inflation could well surprise on the upside this year."

Milburn has the view governments are "rigging the markets" by forcing investors into safe havens so they can tax savers to reduce the government debt burden.

"This is why we have fairly low duration," he said. "We are not zero duration yet but we are happy to go that way when the time comes."

Elsewhere, Milburn and Roberts have begun to rotate out of US high yield and into European high yield debt after the former outperformed Europe by 7% last year.

Milburn said: "The high yield dilemma is when to buy. It is not time to go overweight but you should not be significantly underweight either."

He said he is slowly moving out of US high yield into European names as it looks cheap compared to other fixed income asset classes.

"The market is discounting half of the European universe will default over the next five years. This is not likely," he said.

Instead Milburn - who also runs the £485m Kames UK High Yield Bond fund - said there will be a "watershed moment" in the eurozone debt crisis where investors realise the worst is behind them.

"We expect Europe to lurch from crisis to crisis but there will be a watershed moment when certain actions help us get over it. It is not going to be a ‘big bang' moment, it is more than likely going to creep up on us.

"However, I do not want to sound too bullish. Europe will get through this but not 100% intact and will remain immensely volatile. We remain defensive as things will get worse before they get better."

Roberts added: "2012 will continue to be volatile but will probably be more dull than people expect. A messy breakup of the euro is unlikely in the short-term, although we cannot rule it out over the longer term which is why we remain slightly conservative with high yield and government bonds."

Meanwhile, Kames has recruited a trio of analysts to its fixed income team bringing the number of members to 21.

Debbie King joins the high yield team from Intergen, where she was a financial analyst, while Garvin Peoples has joined from PWC to work on the investment grade funds.

Paul Dilworth has moved in-house having previously worked on Kames' performance measurement team. He will work alongside Gregory Turnbull-Schwartz on financial credit analysis.