Franklin Templeton’s Zahn: Fixed income opportunities in Europe
We often see fixed income investors looking for other opportunities when interest rates are going up – as we are seeing in the UK. Once this rate rise is implemented, we could see UK bond markets underperform, which is why we don’t currently own UK gilts and are underweight the UK market as a whole.
Therefore, UK investors are looking elsewhere, and in our view, both Central and Eastern Europe, particularly the peripheral countries, are looking attractive for investors on a number of metrics at present.
Mainland Europe is currently experiencing slow growth and we would expect that to continue. In addition, inflation is at very low levels on the continent and is close to zero in some countries; again we expect that to continue. However, the prevalence of a standardised view on Europe as a whole obscures the clear differences in both growth and investment opportunities between European regions, and indeed specific countries. Europe could offer some of the more attractive fixed income investments over the medium term – particularly in countries beyond the core members that offer attractive yields, especially when countries are judged on their individual merits.
Despite the problems experienced across Europe over the past two to three years, the periphery countries have made a number of solid fundamental adjustments, and we always encourage investors to focus on the growth and debt metrics of individual European countries, rather than taking a stock view of Europe as a whole. Both Italy and Spain, for example, have made good progress and whilst Italy’s debt to GDP dynamics are high, you tend to get compensated for it.
These countries are also benefiting from a very accommodative Central Bank, and the ECB have cut rates, and introduced a negative reserve interest rate, as well as an asset backed programme, all with the impact of making fiscal policy easier. In contrast, efforts made in both the US and UK appear to be tightening policy.
In our view, core European countries such as Germany and France are fully valued. France in particular is being sluggish in addressing its fiscal problems, meaning that growth is slow. In contrast to what many would expect, the core European countries still have a lot of work to do to address some fundamental issues, whereas, in a number of cases, the periphery countries have gone ahead and done it.
In Eastern Europe, the debt to GDP ratio is attractive and overall fiscal dynamics look incredibly good. Poland in particular is showing strong fiscal metrics combined with a superior yield compared to core Europe, and is viewed favourably for its tight discipline and relatively low level of borrowing. Poland’s economy also appears to be gaining momentum and the latest IMF forecasts predict growth will pick up from 1.3% in 2013 to 2.4% in 2014, while some analysts estimate the latter figure could be nearer 3%.
Countries like Poland are in good shape at present and are often displaying better qualities than many in the Eurozone. Lithuania is similar, and has now been accepted to join the Euro in January of next year which is a positive development – we usually see country bonds do relatively well after such a move. This follows solid progress over recent years in successfully reducing its deficit to around 3% of GDP, resulting in the country’s debt-to-GDP ratio stabilising at a little over 40% in 2012.
Latvia is another country we invest in and like – it already forms part of the Eurozone, but is still considered as part of Central and Eastern Europe and the valuations looks attractive from our perspective.
What is clear is that several countries across Central and Eastern Europe are currently demonstrating superior growth and fiscal metrics compared with many other Eurozone countries. As such, those countries are offering good value potential. Their fiscal credentials and efforts in structural reform have meant they can progress at a faster rate compared with other countries across the Eurozone, where political consensus is often harder to achieve. Their track record on growth has also looked superior, in light of momentum in their respective economies.
The attractive opportunities offered by countries like Italy and selective central and eastern European countries, highlight the need for investors to make judgements on countries’ individual merits, rather than taking a wider European view. Europe is experiencing slow growth, low inflation and an accommodative central bank, all of which should be supportive of European fixed income. Therefore, Europe is a good place for UK investors to look for fixed income returns that are not too far from home.