Bond Funds Bank on Italy's Past Form to Buy Amid Vote Jitters


(Bloomberg) -- Italy’s looming election is widely seen as this year’s biggest political risk in Europe, but the bond market isn’t unduly worried.

The yield premium on the nation’s 10-year debt over German bunds is on course for a fourth quarterly decline, reflecting solid investor confidence that’s in contrast with the trend seen in France’s markets before it went to vote last year. Brian Tomlinson, a money manager at Allianz Global Investors GmbH, favors buying 15-year Italian securities against five-year German ones, and Fidelity International is picking up Italy’s notes versus Spain’s.

The bullishness is based on a couple of things: for Tomlinson, buying the bonds at times of heightened risk has historically paid off thanks to their relative resilience, while Fidelity draws comfort from the fact that the securities are among Europe’s most liquid. Italy’s investment-grade ratings and yields that are among the euro area’s highest have buttressed demand for its assets over the past year, against the backdrop of a regional economic rebound.

Bond Funds Bank on Italy's Past Form to Buy Amid Vote Jitters

“It has always paid to buy the weakness in Italy and it won’t be any different this time,” Tomlinson, who helps to oversee about half-a-trillion euros ($613 billion), said in an interview in London. “Longer-dated Italy is definitely an attractive consideration.”

The latest challenge for investors in Italy’s debt comes in the form of the March 4 election, with no party within the nation’s fragmented political system seen likely to secure an outright majority. With the euroskeptic Five Star movement leading the polls and given the prospects of a hung parliament, the vote has been billed as a key risk to a resurgent Europe.

Narrowing Spreads

Still, the extra yield on Italian 10-year government securities over bunds fell to 120 basis points on Feb. 7, the lowest since September 2016. The spread climbed six basis points to 133 as of 11:32 a.m. in London on Tuesday, amid a wave of new supply. The yields of 10-year Italian and Spanish bonds stood at 2.11 percent and 1.50 percent, respectively.

While spreads versus Germany have narrowed, Italian bonds have trailed gains in Portuguese and Spanish counterparts that have benefited from a slew of credit rating upgrades. That’s partly because of the risk premium priced into Italy’s notes ahead of the vote, according to Andrea Iannelli, a money manager at Fidelity International, which oversees $323.7 billion.

“We are quite happy to hold Italian risk knowing that we can trade it quite tactically if we want to because it’s liquid,” Iannelli said. “It’s easy to go in and out with little transaction cost.”

‘Risk Event’

Italian bonds are among the region’s most liquid because of relative high issuance -- the nation’s outstanding debt equals about 130 percent of gross domestic product -- and active futures-market trading in the securities.

Investec Asset Management has designated the upcoming vote as a “risk event” and is prepared to bolster its “modest” position in the country’s securities.

An Italian electoral law passed last year encourages the formation of coalitions, something Five Star have traditionally opposed. That leaves a pact between center-right parties -- including Forza Italia, led by the former prime minister Silvio Berlusconi -- as the base-case election outcome scenario for many investors despite signs of disagreement. Adding to uncertainties is the fact that just over a third of seats are elected “first-past-the-post” while the rest are assigned on a proportional basis.

That makes it difficult for investors to rely on polling and means that the possibility of a surprise outcome is an underestimated risk, according to Russell Silberston, a money manager at Investec, which manages around $124 billion of assets worldwide.

“We have a modest short, but will take a more aggressive position if we feel a messy election has a negative impact on our portfolio,” he said. “Nobody seems especially concerned this time but there is clearly room for a period of protracted uncertainty.”

Furthermore, the election comes at a time when the European Central Bank is scaling back its asset-purchase program, which had Italian bonds as its biggest beneficiaries. While the ECB reduces its buying, demand from other investors should pick up and support the market, according to Allianz’s Tomlinson.

“There is still enough yield demand from investors to step into the shoes when the ECB is walking away,” he said. “Don’t think that the ECB leaving the purchasing scene should contribute to spread widening because the fundamentals in Europe are fairly healthy, the euro is strong and is expected to be stronger, so there is no existential threat to the euro zone currently.”

©2018 Bloomberg L.P.

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