Fixed Income  

Managers target European peripheral bonds after sell-off

Managers target European peripheral bonds after sell-off

Bond managers have insisted peripheral European bonds offer good value following a significant sell-off across the market.

Peripheral bonds – those issued by under-pressure eurozone countries such as Spain, Italy, Portugal and Greece – have been struggling in recent months due to uncertainty surrounding Greece’s possible exit from the European Union.

But the bonds spiked upwards last week after European Central Bank (ECB) president Mario Draghi warned that further bond market volatility lay ahead and revised higher his forecast for eurozone inflation.

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His comments pushed the yield on 10-year government debt from both Italy and Spain up towards 2.2 per cent, whereas both countries’ bonds had been around 1.4 per cent in late April.

But Baring Strategic Bond fund manager Guy Dunham, who has 29 per cent of his portfolio invested in peripheral Europe, said he was doubling his position after the sell-off.

Mr Dunham said in April he had reduced his fund’s sensitivity to rising interest rates, which can erode returns from bonds.

But he is now looking to buy longer-dated debt, a move that exposes the vehicle to potentially higher returns, but also higher losses if the bonds continue to sell off.

“There are a lot of things to be positive about,” he said.

“We are seeing the benefits of political reforms in Italy and the benefit of reforms in Spain. On a long-term basis we are happy to be overweight peripheral versus core Europe.”

While the European Commission has a myriad of issues to deal with, Franklin Templeton head of European fixed income David Zahn said the recent volatility reflected the positioning of some investors as opposed to any “underlying fundamentals of the eurozone”.

“Italy, for example, has turned around its structural budget deficit into a surplus and now appears to have exited its recession, whereas Spain has reformed its labour market and its economy has been growing more strongly in recent months.”

While the market has been getting increasingly concerned about the future of Greece, Aberdeen’s Luke Hickmore said the politicking had thrown up a buying opportunity.

Mr Hickmore, who is co-manager of the Aberdeen Strategic Bond fund, said the ECB’s quantitative easing programme had compressed the spread – the difference in bond yields – between German bonds and Italian and Spanish debt from 1.5 per cent to 1 per cent.

But the recent sell-off had pushed that spread wider again and Mr Hickmore said that represented good value in peripheral debt.

The Aberdeen fund had no investments in either Spanish or Italian sovereigns at the start of the year but it currently has around 1 per cent invested in each.

Mr Hickmore’s outlook remained upbeat. “The value in Italy and Spain is clear,” he said.

But Mr Zahn pointed out that Germany, the traditional engine of eurozone growth, was not growing as robustly as most would have hoped, especially “compared with other economies in the region that have faced headwinds in the past and are now doing better”.