December 19, 2011 / 12:30 PM / 8 years ago

Funds edge back into euro zone peripheral debt

* Returns tempt buyers despite concerns

* Managers buying Italian debt

* Recent EU summit far from silver bullet

By Tommy Wilkes and Sinead Cruise

LONDON, Dec 19 (Reuters) - Fund managers are finding the eye-catching returns on euro zone peripheral bonds too good to resist, and have begun to buy back into the crisis-hit countries’ bond markets despite worries the region is still far from resolving its debt crisis.

As governments across Europe’s Southern belt wrestle with record costs of borrowing and faltering economies, some asset managers are dipping a toe back into peripheral debt markets to grab once-in-a-lifetime yields that dwarf those offered by UK gilts or German bunds.

“Our view over the last several weeks is there has been a significant sell-off in the peripheral markets, especially Italy and Spain. Clearly valuations are looking more attractive than they were,” Kevin Anderson, global CIO of fixed income and currency at State Street Global Advisors, told Reuters.

Most managers stress the change of sentiment is down to price, particularly in view of Italy, where 10-year government bonds are trading at close to 7 percent. But it does not reflect confidence that the agreement by European Union leaders earlier this month to draft a new treaty for deeper euro zone integration will solve the crisis.

Anderson, who leads a team running around $375 billion in fixed income assets, said he was under no illusions about the struggle Italy faces in rolling over its debt next year but that the prices were tempting him to cut underweight positions.

State Street still remains broadly underweight peripheral debt and is yet to change its position on Spain where yields have failed to reach Italian levels, the manager added.


Many managers believe European policymakers will ultimately prevent an Italian or Spanish default, whether through a hard restructuring or the sort of voluntary arrangement now being hammered out between Greece and its private creditors.

That view was boosted at the recent EU summit when German finance minister Wolfgang Schaeuble said private sector involvement in a Greek debt restructuring was a one-off so long as bonds bear no collective action clauses.

Rupert Watson, head of asset allocation at Skandia Investment Group, said buyers for peripheral debt were most likely creeping out of the woodwork because it was so hard to envisage an “utterly devastating” Spanish or Italian default.

“As a result, you have to reckon that as long as you have guts, and the ability to withstand short-term volatility - that at least being neutral, if not slightly overweight, is now a good idea,” he said.

Fear of missing out on the punchy returns on offer is also stirring some managers to action. Italy has proved the most attractive market for those keen to grab ‘first-mover advantage’ but some have also taken a stab at Ireland and Portugal.

“We’re still adding to those positions, at the right prices, it is a good opportunity. If we can buy at the right price, we will buy,” Kathleen Gaffney, a Boston-based, co-portfolio manager of the $19 billion Loomis Sayles Bond Fund, said.

“When you start to see something begin to fray, that is when we start to think it through. You may not know how things get resolved or what the answer is going to be but for us, it was as simple as either the (European) Union holds or does not hold.”


Managers are still unconvinced policymakers are much closer to finding a resolution to the debt crisis after the Dec. 9 summit, where EU leaders also agreed to lend more to the International Monetary Fund to help it aid euro zone strugglers.

These steps, together with a leveraged EFSF - the existing bailout fund - are intended to boost help for troubled euro zone countries as they try to refinance. Italy has 150 billion euros in debt falling due between February and April next year.

Markets failed to cheer the summit, disappointed the European Central Bank ruled out boosting its purchases of troubled countries’ debt, though Spain did see solid demand for its bonds in an auction on Dec. 15.

If Italy does default on all or part of its $2.5 trillion debt pile, most similar risk assets would suffer and therefore it makes sense to pick up the return boost that the country’s debt offers over other sovereign bonds, investors believe.

“If you are going to take a risk, then arguably one could focus the ‘risk on’ portion of a portfolio on Italian bonds at the expense of other lower yielding ‘risk on’ securities, with the remainder in the very safest assets,” Tim Haywood, who runs hedge fund strategies at Swiss asset manager GAM, said.

Haywood said he has been selling Russian bonds in favour of Italian on the assumption if Italy defaulted, all risk assets would suffer but if it coped, its debt will outperform Russia.

Loomis Sayles’ Gaffney said opportunities to buy mispriced debt were cropping up all over Europe; managers just needed to be willing to ride out increased volatility for the medium term.

“We were buying in U.S. corporates in 2007 so we are used to moving early. We might not see the best returns on Greece or Portugal but in Ireland we have, and I am confident the rest of our positions will work out well,” she said.

“When I said that a couple of days ago, people looked at me like I was nuts. If you are wrong, obviously you will lose. But if we are wrong, then we all lose.” (Editing by Jon Loades-Carter)

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