Aviva’s Higham: Spain may be too big to fix

Spain will be the next major hurdle facing bond markets, says Aviva Investors’ Chris Higham.

The manager of the Aviva Corporate Bond and Strategic Bond funds said whereas the smaller economies of Portugal and Ireland are recovering, Spain and Italy may be too large to fix.

He said: “Spanish unemployment is already at 27%. Will they be able to make the economic adjustments in time before the political will to do so falls apart?”

Higham (pictured) believes the euro will stay intact but he foresees volatility will continue, possibly for the next decade, as market participants have such divided views on the final outcome.

He highlighted radical changes in the bond market resulting from the crisis. For example, it is now the case that some corporates are rated more highly than sovereigns and are trading on lower yields.

Higham gave the example of Telefonica which is rated BBB+ compared to the Spanish government on BBB-.

He said: “British Telecom is rated BBB and the UK government is AAA. Should that really be the case?”

Managers must also find different ways to “derisk” a portfolio because “traditional risk-free assets are not behaving as they should”, Higham added.

In the past, managers could simply increase their exposure to gilts, as they used to be negatively correlated with higher yielding assets, but this relationship has recently reversed, he said.

“Gilts now increase risk in the portfolio,” Higham added. “We are more likely to use CDSs for risk reduction.”

Higham is playing the current environment by no longer buying 30-year paper and instead focusing on short-dated debt. His asset allocation is also more frequent as the typical business cycle has shortened from five years to two or three years.

The manager is cautious on new issues and only selects those “from a name and with a price we like” and with the intention of holding the bond for at least five years. Tactical trading is now too risky, he said. 

Higham recently trimmed the Telefonica holding he bought in July, as it was up 12%, and he continues to buy in the market’s “risk-off” periods. One example of such a trade is Barclays, which he purchased after the LIBOR scandal broke.

He admitted liquidity in the bond markets is a problem, but that has been the case since 2008. Currently the situation is manageable, but a rise in interest rates might encourage money to leave the market and create trouble, Higham added.

 

This article was first published on Investment Week

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