Conviction AM reverses gear on Italian, Spanish bonds

Italian and Spanish bonds have once again become a risky proposition, prompting contrarian investor Conviction AM to reverse its decision to buy them

Parisian boutique fund manager Conviction Asset Management has withdrawn its investment in short-term Italian debt and cut back on other exposures to the country, as well as reducing its exposure to Spain, after the risks of holding those assets have returned markedly.

The weight of pressure on Italy’s economy has caused fund manager Alexandre Hezez and the firm’s president Philippe Delienne to switch their short-term outlook on the country to negative.

In October 2011, Conviction Asset Management announced it had begun investing in Italian, Spanish and Irish bonds, a contrarian decision given the high volatility experienced in the peripheral European bond market since August of that year.

The ECB’s asset purchases alongside its promise to give unlimited liquidity prompted the firm’s move. A number of other French managers followed suit when in December 2011 the ECB announced its long-term refinancing operation (LTRO). They anticipated the intervention would further bring down yields on the peripheral European bond market.

In the first few months of 2012 that prediction proved correct. But the positive effects of the ECB’s long-term refinancing operation (LTRO) have worn off. Spreads on Italian and Spanish bonds have again reached dangerous levels.

Six months on from its contrarian decision, Conviction now holds less than 2% of its portfolio in Italian assets – a mix of mainly Italian investment grade corporate debt, high yield bonds and equities. Between 30 December 2011 and 23 March 2012, the firm took large positions of more than 30% in mainly Italian sovereign debt, as well as some other asset classes. It subsequently sold off that debt. It resumed purchases of Italian debt and other asset classes on 30 March, but as a greater mix and only ever making up 5% of the overall portfolio. On 13 April, it sold off all its Italian sovereign bond positions.

Italy will need almost €20bn of new financing in May and June to fill the gap left if private non-domestic investors decide not to roll their exposure to its debt. Since the beginning of 2010, foreign investors have pulled back from bond markets in Belgium, Italy, Spain, and Ireland, according to official data and debt agencies.

Spain’s non-domestic sovereign financing gap is not as high as Italy’s, estimated at around €7bn. The IMF forecasts a growing debt trajectory for both economies to 2016, but the level of public debt in Italy is already much higher, at more than 100%, and is set to remain around that level.

Spanish house prices are down, and could fall by another 20-30%. Non-performing loans are on the rise, by around 3% more than in Italy. Spanish banks meanwhile hold €30m in net domestic sovereign debt, and Italian banks €10m net of their country’s sovereign debt.

As of 30 December 2011, Conviction’s portfolio only ever held up to 0.1% exposure to Spain, and quickly reduced its sovereign bond allocation between 30 December and 13 January. As of 20 April, it held just under 0.01% of investment grade Spanish corporates and some high yield debt.

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