Barings' Cole: Why we bought £350m in Italian bonds

Barings' multi-asset team has bought £350m in Italian government bonds in the expectation European banks will use the ECB's Long Term Recovery Organisation (LTRO) to buy government debt.

Andrew Cole, the director of strategic policy who works alongside head of multi-asset Percival Stanion, said although other fund managers may look on them buying up Italian government debt "in horror", they will soon understand why when yields fall further.

"We have been increasing exposure to risk assets over the past six weeks and we have been reducing our Australian government debt exposure in favour of Italy.

"We think the banks in Europe will utilise the LTRO facility, leading to the risk of a bank or financial institution's collapse to be diminished, and use this liquidity to buy government bonds. This could be quite a profitable trade for them and it will help replenish capital.

"We see a self-help cycle materialising. Italy is not going to go bust and this is our way of getting exposure to the improved liquidity. The problem was the very high interest rate it was forced to pay on debt and once that goes down the situation will improve. "

The multi-asset team, which runs the £5bn institutional multi-asset mandate, the £100m retail Multi Asset fund and the £4bn Dynamic Asset Allocation fund, has decreased its holdings in Australian government bonds, seen as a safe haven by many, from as much as 20% last year to 11% to finance the trade.

Cole explained: "We reduced Australia as we recognised that the benefits were increasingly recognised by other investors hence the rise in prices. We also wanted to increase risk. Some may look upon us in horror buying up Italian bonds but they will be less surprised when yields fall another 150 basis points."

Its allocation to 10-year Italian government bonds now makes up 7% of the wider portfolio.

He added the chances of Italy leaving the euro are less than Greece as Italy is needed, particularly by Germany, for trade and commerce reasons. Greece is not as crucial and Cole fully expects the country to be "expelled from the euro".

Recently Italian government bonds have been rallying. According to Thomson Reuters data, the Italy 10 Year Benchmark is yielding 5.74%, down from the record high of 7.48% it reached in November.

"We are not going to chase the market but if there is a setback in the rally, which is going quite nicely, we are likely to add to our position," said Cole.

Although the team has made their first foray into Italian bonds since the crisis they are not yet buying European equities. However, they are adding risk to the equity segment of the funds by buying US, Chinese and Russian equities and have switched physical gold exposure for gold mining shares.

"A lot of people wondered why the gold miners were not doing better than they were last year but now we see an environment where the relationship between the gold price and the mining stocks re-establishes itself."