German bond managers explain their eurozone bearishness

German fixed income asset managers, caught between domestic Bunds yielding almost nil and peripheral yields reflecting high risk, are taking a generally pessimistic view of the eurozone’s condition and future prospects, according to research from Standard & Poor’s.

Interviews that S&P analyst Kate Hollis (pictured) has conducted with various European fixed income managers since mid-October found German managers among the more bearish.

One went as far as to say that, without a European risk-free asset, German Bunds were as valuable as Italian debt, Echoing a growing number of his equities-focused countrymen, another German fixed income manager said the European Central Bank would ultimately have to step in to monetise more troubled debt.

Jörg Warncke, head of Union Investment’s Europe fixed income team, was “very bearish” when Hollis saw him, and believes Greek default is inevitable, Italian bank deposits are increasingly being moved to German banks, and that the EFSF insurance solution will not work.

Hollis added Warncke noted the ECB will, eventually, have to monetise sovereign debt, “but that it will be years before the politicians reach a sustainable solution”.

Bank recapitalisation will not be enough, another credit crunch is pending  and there is an even chance of a recession.

Arif Husain, manager of AllianceBernstein’s European Income fund, told Hollis “there is no risk-free asset in the eurozone any more, no lender of last resort large enough to back-stop the whole region, and that Bunds are ultimately the same credit at Italy in consequence”.

Hollis noted of her wider conversations with European fixed income managers: “While investors generally have not changed their mandates again this year, managers have changed how they manage their funds.

“Many were overweight Italy a year ago, to balance their underweight exposures to other peripheral countries, [but] this is changing.”

France is being added to the list of countries, already including Spain and Italy, a number of managers are now underweight.

Hollis also noted the importance of benchmark choice in fund composition.

“Managers’ portfolio positioning has been affected by their benchmark index -JP Morgan’s still includes non-investment grade sovereign credits, while iBoxx does not – but also the type of mandate.

“‘Safety players’ such as Delta Lloyd have had very conservative country exposures, even against their conservative index, while some total return mandates, such as Petercam Bonds EUR, have been much more aggressively positioned.”

Hollis also noted a difference between Continental and UK managers. Continentals are increasingly bearish, while UK-based counterparts “are generally unconvinced that politicians will be able to solve the problem quickly – but are more confident about the economic outlook”.

Among other of Hollis’s interviewees, manager of Zantke Euro Corporate Bonds Dietmar Zantke said he believes the eurozone will survive as a transfer union, that the banks will be bailed out, but that the economy will slow and there may be a shallow recession.

The team at Raiffeisen also believes the ECB will need to buy more bonds as the EFSF will not work. “They do not expect fiscal union or a eurozone break-up or any political resolution in the short term, and expect the market to remain volatile with much headline risk for at least another year,” Hollis said.

Others are more sanguine. For example, Hollis said Jonathan Gibbs at Standard Life believes the eurozone will hold together, as it will not be possible to negotiate the necessary treaty changes for a break-up, and that there will be no double-dip.

Craig MacDonald, manager of the Standard Life Investments SICAV European Corporate Bond fund, does not believe banks will need to be recapitalised on a large scale unless Italy and Spain default.

Michael Krautzberger at BlackRock believes some Tier I issues might miss coupons and so he is avoiding them.

Alliance Bernstein’s Husain agrees – but thinks the market is priced to cover four years’ coupon deferral on average.

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