Analysis: U.S. funds boost holdings in shaky European debt

By Daniel Bases

NEW YORK (BestGrowthStock) – The amount of cash invested by U.S. funds in European peripheral government debt rose in the first three quarters of 2010 as some investors bet sovereigns would not be allowed to drown in their own debt.

The data covers the run-up to Greece accepting a 110 billion euros ($147.5 billion) aid package from the European Union and International Monetary Fund on May 2.

Ireland subsequently was given an 85 billion euro bailout on November 26.

Some in the investment community remain committed to scooping up debt of the peripheral euro zone, which carry significantly higher yields. Others are avoiding the continent in general.

Greece’s yield on 10-year bonds is 9 percent above the German benchmark while Ireland is 5.6 percent higher, down slightly from last week’s historical peaks.

“Last Wednesday, when the mood seemed to be particularly cataclysmic, my view was close your eyes (and) buy a basket of these things,” Jim O’Neill, chairman of Goldman Sachs Asset Management, told Reuters 2011 Investment Outlook Summit in London on Monday.

“Put them away for six months, and you’ll probably be pretty happy. I still think that is the case,” he said, noting European policymakers are offering increasingly bolder ideas for tackling the problem.

But the lingering long-term question remains: Can Greece or Ireland, or perhaps another of the vulnerable nations, maintain fiscal austerity and grow their economies enough to pay off their obligations? Or will they force the European Union to take more drastic measures, such as allowing a default?

WHO DARES

So far, U.S. fund managers remain optimistic.

Data from Thomson Reuters’ Lipper service showed in the first three quarters of this year U.S. funds managers put an additional $284 million into the debt issued by the governments of Portugal, Italy, Ireland, Greece and Spain, a 6 percent increase from December 31, 2009.

The total held by U.S. accounts amounted to $5.22 billion.

In that time, 56 funds established positions while 30 sold them, leaving 140 with exposure to the debt.

The largest holder of peripheral European government bonds, Oppenheimer International Bond fund, trimmed its holdings by 7 percent to $1.15 billion, Lipper data shows. But No. 2 on the list, American Funds Capital World Bond fund, increased their holdings by 73 percent to $708.8 million.

A “WOW” FACTOR

The widening spreads over benchmark German debt continues to draw some of the biggest investors to the peripherals, confident they would be backstopped by governments or the IMF.

Dan Fuss, the vice chairman of Loomis Sayles, has become one of the biggest holders of Irish debt. He oversees a portfolio worth $150 billion.

“I think there is tremendous value in absolute and relative terms. In relative terms, it is ‘Wow!’,” Fuss told Reuters.

As of September 30, Loomis Sayles was the largest holder of Irish sovereign debt due in 2018, according to Thomson Reuters data, topping out at nearly 4 percent of the outstanding par value.

Yield spreads have narrowed slightly, helped by European Central Bank buying of government bonds. The latest data shows their purchases rose last week, but there has been no word on how much it might spend or how long it intends to buy.

A U.S. official told Reuters on December 1 that Washington was ready to support the extension of the bailout fund via an extra commitment from the IMF.

ECB Governing Council member Guy Quaden on Monday backed the idea of increasing the size of the fund. Germany, the largest EU country, has pressed for bondholders to start taking a share of the losses in the event of a sovereign default by 2013. But even then, any restructuring involving the private sector would be undertaken on a case-by-case basis without any automatic provisions, under current proposals.

FLARE-UPS LIKELY

The peripheral debt’s actual impact on the benchmark Barclays Capital Global Aggregate Bond Index is relatively small when viewed by their weightings. All together, they equal just 7.75 percent versus 37.9 percent for the United States. Euro-zone nations overall account for 33.2 percent of the index.

Nic Pifer, team leader for global fixed income at Columbia Management, a division of Minneapolis-based financial services firm Ameriprise, said the Greek crisis hit hard in the spring, prompting his team to cut its exposure by 75 percent. They have not held much of the peripherals and remain underweight.

“I think you could argue that Spain or Portugal should be moving faster on reducing their deficits. They have certainly introduced a number of measures and are kind of going in the right direction, but are they moving fast enough to give the market real confidence? Not really,” said Pifer, whose team manages $6.2 billion in global fixed income, currency and emerging market debt assets.

“Looking out 6 to 12 months, I think it is entirely likely that we get flare-ups of these issues every few months. The problems haven’t gone away,” he said.

One investor isn’t buying any of it and has had the foresight and patience to wait for the financing problems to come home to roost.

“European sovereign debt is in serious trouble and represent high risk investments at this point,” said James Melcher, founder and president of macro-global hedge fund Balestra Capital Ltd, one of the few investors who correctly forecast the housing and sovereign debt crises.

Balestra does not currently own any European government debt, and in the past has purchased European sovereign credit default swaps. Melcher declined to comment on the firm’s current positions.

“Risk free” doesn’t apply anymore. It applied to the great growth decades after World War Two, but the game has changed. The rules are different now.”

(Additional reporting by Jennifer Ablan and Alina Selyukh in New York and Mike Dolan in London; Editing by Padraic Cassidy)

Analysis: U.S. funds boost holdings in shaky European debt