Veritas – Will Europe’s leaders poison future pensioners with debt?

It should not have been surprising Germany failed to sell so many of its Bunds at auction yesterday, despite their being a lone ‘safe harbour’ among troubled European debt.

It should also come as no surprise if Europe’s investment regulators and governments move to stop ‘buyers’ strikes’ happening again, by artificially boosting debt demand.

Yesterday’s Bund auction failed to attract bids for about one third of the total AAA-rated 10-year paper offered – about twice the historic shortfall in such auctions. Both the euro and Dax fell sharply.

But it was only a question of how long before Berlin followed where Athens, Madrid, Dublin and Lisbon have been before.

Ben Olmstead from institutional search monitors eVestment Alliance, said searches for European fixed income – from core and intermediate-duration to long-duration mandates – recently sat at the bottom decile of all domestic asset class searches.

Germany does not face the dire debt problems of each of its southern neighbours. But Berlin faces all their woes indirectly, and in aggregate, by having one of few remaining chequebooks still open to bankroll debt-laden neighbours, via its €211bn contribution to the bailout fund.

Yesterday, even risk-averse investors found it all too much to bear.

A comment that Michael Schmidt, head of equities and managing director at Union Investment, made recently about Treasuries could equally apply to Bunds: “Not a risk-free return, but now a return-free risk”.

No matter how much pensions’ investment models suggest diversifying away, the eurozone’s governments and treasuries cannot afford for investors to stop buying their almost return-free risk asset, in Germany currently yielding about 2%.

Germany’s fund industry association, BVI, argues strongly for broadening allocations beyond bonds, but German pensions remain 84% in fixed income or cash instruments, according to Union Investment.

If investors heed the BVI’s advice, then the EFSF, then ECB and possibly also IMF will have quite some buying to do.

A growing number of fund managers believe, instead, that governments will simply ‘force’ their local institutional investors to demand debt via regulation.

European pensions and insurance companies already face strict limits on investments in risk-assets, and managers say, as long as debt can be classed as non-risk, demand for it can be artificially stimulated – even at 2% yields, which loses out to the eurozone’s modest 3% inflation.

(Brussels already tried to convince Beijing and Tokyo, wholly unsuccessfully, to demand it, too. Helene Williamson, manager of First State Investments’ Emerging Markets Bond fund, was unsurprised leading developing economies declined.)

One European manager said regulatory enforcement of domestic investors was “forcing today’s toxic assets into the retirement plans of future generations, and that hardly seems fair”.

That is true.

But in an increasingly ugly environment for European debt, Berlin hampering the ECB from buying much more, and the large foreign investors largely staying away, forcing local demand is one of few options left to Europe’s cash-strapped governments.


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