As European countries see their investment-grade ratings topple and the US approaches zero-hour on a debt-ceiling decision, some fund managers are removing certain eurozone sovereigns from their fixed-income portfolios and shortening bond-investment maturities.
One of them is Kevin Anderson, global chief investment officer of fixed income and currency at State Street Global Advisors (SSgA) in London, who spoke to AsianInvestor yesterday during a trip to Hong Kong.
Ireland and Portugal became the latest victims of downgrades to junk status, the former last week and the latter the previous week, and contagion appears to be spreading. Indeed, says Anderson, the shorter-term focus for the eurozone over the summer is likely to be as much about the political discussion that is unfolding and investor sentiment as about fundamentals and economics.
He cites last week’s spike in Italian government bond yields as an indication of how jittery the markets are. They briefly exceeded 6% last week – their highest since the launch of the euro – and remained close to that level yesterday, despite the country having stronger fundamentals than Spain, Greece, Ireland or Portugal.
Meanwhile, in the US, Anderson expects to see Treasury yields gradually rising from what Anderson feels are “unsustainably low” levels, in line with what he expects to be a “slow, cyclical recovery” in the country’s economy.
What might also contribute to Treasury yields rising are concerns over “lack of traction” in moving the debt burden from the private to the public sector. “As the debt ceiling [issue] becomes more focused in investors’ minds, we could certainly see yields rising,” he adds.
In Asia, a key focus remains combating core inflation, says Anderson. There is a lower output gap and therefore less excess labour capacity in Asia than in Europe and the US, he adds; that's one reason inflation is not a significant problem in the West.
Although SSgA has a positive view on Asia’s bond market strategically and there is scope for continued rate rises in the short term, a continued patch of slower growth in the US would negatively affect Asia. That said, the firm doesn’t expect a hard landing in China. Anderson argues there is a lot of scope to moderate house prices and probably room for more rate rises and tightening of bank reserve requirements.
So how is SSgA positioning its client portfolios in light of its general outlook?
For one thing, some clients in Asia and elsewhere are switching from standard global government bond indices to more focused, customised benchmarks, says Anderson. “They are moving away from the concept that all sovereigns are alike to the realisation that there is a sovereign credit dimension now,” he says.
The most proactive institutions have asked SSgA to take Greece and Portugal out of their fixed-income portfolios before they are removed automatically from the benchmark by rating downgrades. “It’s not a wholesale shift, but more and more clients are putting on customised exposure,” adds Anderson.
Another example of a more focused approach is for SSgA to work with an index provider to put together core European bond indices – for example, comprising a 40% weighting to Germany, 40% to France and 20% to the Netherlands. This ensures there is no peripheral-economy bond exposure and only the most liquid AAA-rated sovereigns in the portfolio. Hence Austria and Finland, which are top-rated but not so liquidly traded, would be taken out.
In addition, SSgA has been “cautious on duration” in developed and emerging markets, says Anderson. “Duration is typically around five to six years. We have been trading from the shorter side of that level.”
In terms of specific countries, the firm has been underweight Greece, Ireland and Portugal for some time. Greece fell out of most portfolios last year when it was downgraded to junk status by Standard & Poor's and Moody’s Investors Service in April and June 2010, respectively. As a result, the country is now “in limbo”, says Anderson, because it doesn’t fall into emerging-market portfolios either.
SSgA is closely monitoring the tier-two economies – Italy and Spain – and has more confidence in Italy’s debt fundamentals than Spain’s, despite the bond-yield spike in Italy. “Broadly we are underweight the whole tier-two sector.”