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Record-Low Portuguese Yields Still Attracting Europe’s Top Funds

Away From Europe's Political Noise, Portuguese Bonds Draw Buyers

(Bloomberg) -- For some of Europe’s largest bond funds, the best-performing asset just got better.

Portuguese bonds, which earned the region’s best returns this year, got a further boost in May as Fitch Ratings upgraded the nation’s credit outlook to positive just months after S&P Global Ratings raised its ranking. While that helped push yields to a record low, Portugal remains the “main positive bet” among peripheral euro-area markets at Allianz Global Investors. Amundi, Europe’s biggest asset manager, and Aberdeen Standard Investments are also bullish on the Iberian nation’s debt.

Record-Low Portuguese Yields Still Attracting Europe’s Top Funds

The brighter credit profile is the latest addition to a long list of positives for Portuguese bonds -- from the country’s improving economy and relative political calm to active buying in the securities by the European Central Bank. The region’s stubbornly low inflation and the ECB’s dovish policy tilt have created a “yield-grab environment” that favors Portugal’s debt, according to Ross Hutchison, a fixed-income investment director at Aberdeen Standard.

“We’re overweight Portuguese sovereign bonds in our funds, and continue to hold this position despite the recent rally,” said Edinburgh-based Hutchison, whose firm manages $643 billion in assets. “We think the fundamentals justify a continuation of credit spread tightening.”

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Portugal’s government debt returned more than 3% so far this year, according to the Bloomberg Barclays Global Aggregate Index, beating Spanish and Italian debt, which delivered a 2.7% gain and a 0.4% loss, respectively.

A nine-month rally in Portuguese 10-year bonds saw yields tumble more than 110 basis points, touching a record low of 0.747% on Monday. The spread to German equivalents was about 100 basis points, the narrowest since 2010.

“We think the positive story is set to continue,” said Mauro Vittorangeli, chief investment officer for fixed income at Allianz. “We have been long Portugal before the upgrade to investment grade.” He continues to hold that position and sees the spread to bunds tightening further.

Record-Low Portuguese Yields Still Attracting Europe’s Top Funds

Portugal’s long-term foreign currency debt rating remains at BBB, just two notches above junk. But the country’s allure to traders contrasts sharply with Italy, where an ongoing government standoff with the European Union on fiscal policy has spooked financial markets. The yield premium of Italian 10-year bonds over Portuguese equivalents touched 186 basis points, the highest since records began in 1997.

‘Attractive Story’

“Portugal bonds remain attractive as they still provide some spread with an attractive underlying economic story,” said Isabelle Vic-Philippe, head of euro rates and inflation at Amundi, which oversees $1.6 trillion of assets. “There is little political noise in Portugal. In a low-yield, low-volatility environment we are convinced that spreads should continue to tighten.”

UBS Global Wealth Management’s Thomas Wacker is less optimistic on Portugal, having recently recommended taking profit on long positions as valuations look stretched. The nation’s 10-year yield premium over Spain has collapsed to less that 10 basis points, from about 30 at the end of 2018.

“It will be very hard for Portuguese bonds to outperform from here,” said Wacker, head of credit in the chief investment office at UBS Wealth. “They have done exceptionally well but probably its time for profit taking. Looking forward, the positive dynamics are probably fading. Portugal will also be quite vulnerable to any broader economic weakness.”

Allianz’s Vittorangeli disagrees and is overweight Portugal’s bonds versus those of Spain.

“Portugal is on the positive path to move from peripheral to semi-core,” he said. “It’s still a long run, but I think it can continue.”

--With assistance from James Hirai.

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, Anil Varma, Scott Hamilton

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