Fan of Portugal Bonds Says Reduce Exposure on Fitch Upgrade

(Bloomberg) -- A credit rating upgrade for Portugal’s debt might be the right time to start paring back exposure to it, according to Nomura Asset Management’s Richard Hodges.

That would likely mark a turning point in what has been a “full-blown credit story” for the nation’s government bonds, said Hodges, whose Global Dynamic Bond Fund has outperformed 92 percent of its peers in the past year. More than 12 percent of the fund consists of Portuguese debt. The nation’s bonds have seen a sustained rally for most of 2017 on the back of better economic fundamentals and an improving credit outlook.

Speculation is growing that Portugal’s bonds will earn an investment grade from Fitch Ratings when it announces its review on Dec. 15. This in turn would help lift the composite rating above its current junk status and allow it to re-enter several benchmarks, opening the possibility of conservative funds buying the country’s debt. It would also mean that the trade might have run its course, said London-based Hodges.

“Once that credit story is over, if it’s upgraded then essentially it becomes more of an interest-rate sensitive story where either economics, politics or interest rates will have a stronger influence on the level of Portuguese bond yields,” he said. “So I would suggest that a prudent person who is already long Portugal’s bonds should probably reduce some of that exposure as that story plays out.”

Hodges, whose firm oversees a total of $450 billion in assets, has been a fan of these bonds for a while, telling Bloomberg in July that the “dynamics are changing” for the country and that he was adding to his exposure as it’s been a “very successful trade.”

He is maintaining a long position in Portuguese bonds going into the Fitch decision next month, after the surprise ratings upgrade by S&P Global Ratings on Sept. 15 saw the country shed its junk-bond status for the first time in more than five years. Benchmark yields plunged more than 40 basis over the following days to spur some fund managers to look elsewhere for returns.

Rubicon Moment

Yields on benchmark 10-year bonds have slid more than 175 basis points this year, slipping below 2 percent on Nov. 7 for the first time in more than two years. They were on course for their sixth weekly decline Friday and were at 1.98 percent as of 9:57 a.m. in London. A Fitch rating upgrade could prove to be a “Rubicon” moment that will see Portugal’s bonds trade alongside their peripheral peers, according to Rabobank International strategists including Lyn Graham-Taylor.

Even if Fitch decides to maintain the status quo, Nomura’s Hodges remains upbeat that the “dynamic will play out” with a probable future upgrade from Moody’s Investors Service.

“If Fitch don’t upgrade, any back up you see on Portuguese yields in relation to other peripheral yields like Italy and Spain, you should take that as an opportunity to add exposure,” Hodges said.

To contact the reporter on this story: Anooja Debnath in London at adebnath@bloomberg.net.

To contact the editors responsible for this story: Ven Ram at vram1@bloomberg.net, Neil Chatterjee, Keith Jenkins

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