U.S. investor's Irish punt casts large shadow

DUBLIN/LONDON Wed Nov 21, 2012 2:22pm EST

DUBLIN/LONDON Nov 21 (Reuters) - U.S. asset manager Franklin Templeton's lucrative bet on Ireland could turn into a nasty losing streak if Europe's favourite recovery story falters or its own customers lose faith.

The San Francisco-based investor's aggressive purchase of Irish government debt has helped crown Ireland the best performing bond market in Europe this year. But its holding of nearly one tenth of a highly illiquid market leaves it - and other investors, including the European Central Bank - exposed.

If Franklin Templeton, which declined comment on the issue, were to sell its holding, either if it turned bearish or if its own client investors started to withdraw their cash from its funds, the price of Irish debt could tank, rivals warned.

"It will be like being in front of a train if they want to exit the trade," said Gareth Fielding, chief executive of Quantum Global Wealth Management, which specialises in asset management for central banks and sovereign wealth funds.

"We all like to ride the trends but you don't want to be last out of any position. And in this case, even if you were second to book profits, the trade may have already moved significantly against you."

So far, the U.S. investor's Irish shopping spree has paid off, both for it and Dublin. The yield on the benchmark 2020 bond has fallen to 4.5 percent from 8.5 percent at the end of last year, helping Franklin Templeton's $64-billion Global Bond Fund to earn a return - on paper - of nearly 13 percent over a 12-month period to the end of September.

The asset manager holds around 8.3 billion euros ($10.6 billion) of Irish paper, much of it acquired over the past year, traders estimate using market data that puts Dublin's total debt stock at 88.5 billion euros.

Most of the bonds, they estimate, have been bought by funds controlled by Michael Hasenstab, co-director of Franklin Templeton's international bond department.

A company representative at Franklin Templeton declined to confirm officially how much Irish debt the group holds across its many individual funds. He also said Hasenstab was unavailable for comment.

Hasenstab has said his investment approach is long-term and his funds' exposures to smaller markets are not great as a proportion of assets. He has also said his funds could quickly hedge their exposures in the credit derivatives market.

ONE-WAY BETS

Other overseas investors have bought into the Irish story, particularly since the summer when Dublin successfully sold five- and eight-year paper, its biggest test of market sentiment since a crippling banking crisis forced it out of bond markets in the autumn of 2010 and into an EU-IMF bailout.

"We have seen a lot of interest from the United States and mainland Europe. It has really been those guys leading the charge and forcing yields lower over the last few months," said Owen Callan, senior dealer at Danske Markets, a primary dealer in Irish bonds.

Ireland's sovereign bond market is the euro zone's least liquid after fellow bailout recipients Greece and Portugal, as judged by bid-offer spreads - partly due to the dominant share of the paper now owned by Irish banks and the European Central Bank (ECB), none of which trades heavily in the securities.

Ireland's central bank and local commercial banks hold around 21 billion euros of the bonds, central bank data shows. The ECB holds 15-20 billion euros, according to analysts. Keen to attract new investors, Ireland is preparing a syndicated bond issue for early in the new year aimed at a global market. Franklin Templeton's big holding may, however, put off buyers who fear it could mean unpredictable swings.

"That is one of the strengths of a giant fund. By continuing to buy a certain thing, they can push up the price and the investment can be self-fulfilling," said Stephen Snowden, fund manager at Kames Capital, which does not currently hold any Irish government paper.

"The regret is these trades are one-way bets because it is much easier to get into illiquid small markets than it is to ever exit."

Dublin is also bringing in new products to appeal to Irish pension funds, which are unusually small players in their domestic bond market, holding only 0.5 percent of the paper.

But while pension bosses say they are keen, they are troubled over how Franklin Templeton may use its holdings:

"There has to be concern about what happens if they decide to unwind that position," said J erry Moriarty, chief executive of the Irish Association of Pension Funds.

STILL FRAGILE

In a recent note to clients, Franklin Templeton's Hasenstab praised Ireland's efforts to slash its budget deficit and exit its EU-IMF bailout deal, which ends next year.

"What's been happening in Ireland is positive," he wrote.

"The country, despite facing great adversity, continues to make progress on fiscal reform, and is increasingly getting recognition as a model for other countries."

But others emphasise uncertainties ahead for Ireland.

"While I basically agree on the fundamental improvements in the Irish economy since the top of the crisis, as an asset manager I would never make such a huge singular bet," said Stefan Angele, head of investment management at Swiss & Global Asset Management, whose Irish sovereign exposure amounts to two percent of its European government holdings.

"The still fragile environment in the euro zone is driven too much by politicians and political campaigns."

At fixed income investment manager ECM, Sohail Malik, senior portfolio manager for the Special Situations team, suggested the presence of such a large, private-sector bondholder left him wary of the Irish market: "This kind of miraculous recovery in the Irish yield curve has to be taken with a pinch of salt," he said. "We think it is manufactured to a great degree."

Saying he had been approached by brokers this month offering Irish bonds, he added: "That says to me that someone is very long bonds and wants to start feeding them out to the market."

($1 = 0.7801 euros) (Additional reporting by John Geddie in London; Editing by Alastair Macdonald)

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