March 30, 2012, 9:54 AM
Article from The Wall Street Journal
By Min Zeng
In an ominous sign for Europe’s sovereign-debt crisis, big global asset managers are showing little faith in government bonds sold by the euro zone’s debt-strapped nations, even as these markets have posted an impressive rally this quarter.
While banks and hedge funds have chased bond prices higher, fueled mainly by liquidity provided by the European Central Bank, Pacific Investment Management Co., or Pimco, the world’s biggest bond-fund manager, has slashed its already-depleted holdings in debt of Spain and Italy in February and has said it expects selling to return in coming months.
Raiffeisen KAG has sold Spanish and French debt in recent weeks, holding less than is designated by benchmark indices. Frankfurt Trust Investment shifted its position on Spain back to underweight last week. BlackRock Inc. (BLK), meanwhile, has done no more than dip its toes in Italy this quarter and Fidelity Investments has refrained from buying altogether.
Such big investors regard the policy response until now, including cheap loans for banks from the European Central Bank, as a short-term fix and they believe the euro zone’s structural problems will take time to resolve. Without such big investors, many peripheral nations will face funding challenges, with several having been shut out of the capital markets. This means that the ECB may need to intervene more to prevent sharp rises in borrowing costs, but getting more financial aid from Germany and other creditor nations’ taxpayers could be a tall order.
“At the very top level, liquidity has provided a nicer buffer against volatility but, if you peel back the cover, you are not going to like what you see in terms of structural issues which remain very weak,” said Bob Brown, president of the bond group at Fidelity Investments, with more than $1 trillion assets under management. Brown manages $331 billion in bonds.
Indeed, signs of stress have popped up again this month, with bond yields, which move inversely to their prices, having climbed from recent lows in Spain and Italy. This month through Wednesday, Spanish government bonds have handed investors a loss of 2.34% in dollar terms, shrinking its year-to-dated gain to 3.45%, according to data from Barclays. Over the same time frame, Italy’s government bonds lost 0.4%, though the gain for the year, at 14%, is still juicy.
This doesn’t impress Scott Mather, head of global bond-portfolio management at Newport Beach, Calif.-based Pimco, who predicts bond prices will drop in both Spain and Italy in the months ahead as both nations are likely to disappoint on their deficit-reduction targets. Pimco is a unit of Allianz SE (ALV.XE).
A key issue, Mather pointed out, is that Europe “has not moved convincingly” toward fiscal union even as Germany earlier this week dropped its opposition to an enlargement of the euro zone’s bailout mechanism.
Underlining his concerns, Mather said he holds most of his European exposure in Germany and the U.K. He has sold out of peripheral Europe and has even moved out of countries that many consider “core,” such as France and Netherlands, which he thinks can suffer, given disappointing debt dynamics and political unwillingness to tackle the issues.
The yield on the Spanish government’s 10-year bond traded at 5.433% Friday, a surge from this year’s low of 4.634% in February. Italy’s 10-year government bond’s yield traded at 5.170% Friday, up from the March low of 4.754%.
Yields are still far off the stress levels near the end of last year when Italy’s 10-year yield moved above 7.4%. But the recent increase signals that the euphoria from the ECB’s liquidity–two operations of cheap three-year loans for banks–is wearing off.
Fund managers cited upcoming elections in Greece and France, the risk that Spain could miss its deficit-reduction target again, and the threat of deeper economic contractions in the euro zone. The latter would make it harder for governments to implement austerity measures in line with the strict rules laid down by the European Union.
Spain is seen as the biggest risk by Werner Fey, a fund manager at Frankfurt Trust Investment GmbH in Frankfurt, which manages about EUR15 billion of assets including stocks and bonds. Fey cited problems with the nation’s saving banks, high unemployment and the fact that the government fell short of its fiscal deficit-reduction target.
Christian Zima, fixed-income fund manager in Vienna at Raiffeisen KAG, which oversees about EUR28 billion of assets, said yields on Italian and Spanish 10-year debt could rise as high as 5.75% but this would prompt policy actions to cap further increases, such as bond purchases by the ECB, he said.
Still, Zima said he is wary of downside surprises from the euro zone as he sees the steep belt-tightening carried out in peripheral nations taking a toll on the economy.
“There are so many risks down the road. Stay defensive,” he said.
Article from The Wall Street Journal
