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bargain hunters turn to the periphery

Our team of analysts consulted fund selectors in Copenhagen, Amsterdam, Helsinki, Munich and Zurich, and found that many interviewees plan to reduce their exposure to the traditional safe havens of EU and US government debt. Corporate bonds and emerging market assets are favoured instead. There were even signs that investors are beginning to hunt for equity and fixed income bargains in the battered eurozone periphery.

Western govt bonds

As one Munich-based fund selector remarked, the investment environment has shifted “from riskless interest to interest-less risk”. Bonds issued by many northern European nations have been subject to heightened investor demand this year – resulting in historic low yields, and forcing some non-eurozone governments such as Denmark and Switzerland to spend significant sums fighting a sharp appreciation of their currencies against the euro.

Key Trends

Low yields are leading many investors to plan cuts in their European and US government debt allocations. But sovereign bonds issued by emerging economies are popular, with Finnish and German investors showing interest in higher-risk frontier market securities.
More fund selectors plan to increase their emerging market equity allocations than reduce them, in aggregate, but some have concerns over the region’s economic outlook. German investors say they are focusing more on stock valuations in the developing world.

Demand for absolute return vehicles is growing. Dutch fund selectors are particularly keen to see more hedge fund strategies repackaged in Ucits structures.
Views on EU and US equities are mixed. While most Danish fund selectors expect to reduce their European stock exposure, Finnish and German investors see opportunities. There is broader support for US equities, although Finnish interviewees worry about valuations.
In corporate debt, high yield is likely to remain popular, following significant demand this year. But Dutch and Swiss fund selectors show little appetite. Many investors express a growing interest in the relatively new area of emerging market corporate bonds.

 

For fund selectors, the paltry yields available on government debt are leading many to plan cuts in their domestic and EU sovereign bond allocations. Such shifts are likely to be most pronounced in Finland and Germany, our research suggests, where more than two-thirds of professional investors expect to reduce their weightings during the next year (see graph above).

A similar picture emerges in relation to US government debt, with only Danish fund selectors planning to boost their exposure in aggregate. “I don’t have any and I don’t want any,” said one Helsinki-based interviewee, when asked about his appetite for US treasuries.

EM sovereign debt

In contrast, emerging market government bond funds are likely to see increased inflows. Finnish investors are most enthused by the asset class (see graph on page 16) and are keen to learn more. In particular, they are interested in the differences between local and hard currency strategies, and are starting to look at debt securities issued by so-called ‘frontier’ markets, such as Argentina, Ukraine and Tunisia.

German fund selectors are also focusing on the higher risk/return opportunities available among these smaller developing economies, but worry about the asset class more broadly. Munich-based interviewees are unsure whether China is destined for a hard or soft economic landing, and are wary about the implications for emerging nations if investment flows from the West go into reverse.

Developing world equities

Similar fears surround developing world stocks, with German investors concerned about over-reliance by companies on emerging consumers and the potential for government interventions, following Argentina’s decision this year to nationalise the local assets of Repsol, a Spanish oil firm. Nevertheless, just one in five of our Munich interviewees expect to actively reduce their exposure to emerging market equities over the next year, and many are instead focusing on value – an approach described by one investor as seeking stocks which offer “€1 for 70 cents”.

As with sovereign bonds, appetite for emerging market equities is strongest among Finnish fund selectors. Four in five Helsinki-based investors expect to increase their weightings to the asset class, owing to attractive demographics and valuations in the developing world. While this is likely to be mostly via global strategies, rather than region-specific products, interviewees display a particular interest in bolstering their Asia exposure. Danish and Swiss fund selectors are broadly upbeat on emerging market stocks, with greater proportions planning increases than cuts to their allocations.

European and US stocks

Sentiment towards European equities is mixed, with Finnish and German fund selectors in aggregate planning to boost their weightings to the broad asset class (see graph opposite). Both groups favour large, multinational firms with diversified geographical exposures – a sector also popular among Dutch investors. Some more adventurous German interviewees are additionally seeking value opportunities in the eurozone periphery, despite their concerns over European economic growth.

This stance contrasts starkly with that of Danish fund selectors – the vast majority of whom are planning to reduce their exposure to EU stocks. Indeed, Copenhagen-based investors say they no longer consider pan-European equity funds to be a core holding, and instead prefer to focus on Nordic-specific stock strategies, owing to the region’s relative economic and political stability.

Meanwhile, Danish interviewees are more upbeat on US stocks than other investor group. Fund selectors say they are unperturbed by uncertainty surrounding November’s presidential election, and confident in both the economic strength of the US and the balance sheets of its larger corporations. Finnish investors strike a cautious note on US stock valuations, however. While the asset class is widely acknowledged as a safe haven, companies are fully-priced, they say.

Corporate bonds

As investors move away from EU government bonds, our research indicates that corporate debt allocations will rise. The area generating most interest is high yield – perhaps unsurprisingly, given the large flows into the sector this year (see graph on page 15). Yield-hungry Danish and Finnish fund selectors are most bullish on the asset class, with more than two-thirds of interviewees in these countries planning to increase their exposure, and none expecting to reduce their weightings (see graph above). Copenhagen investors favour short-dated securities, owing to their risk/return profile.

Not all investors are enamoured with this high-risk sub-sector, how- ever. Dutch fund selectors remain unenthused by high yield, while one in five Swiss interviewees expect to actively reduce their exposure. Nevertheless, both of these groups plan to boost their broad corporate bond allocations during the next year. Amsterdam-based investors say yields of 3% to 3.5% are attractive on investment grade debt, although they are willing to pay a premium for short- dated, lower-risk securities.

Another sector that seems destined for greater popularity is emerging market corporate debt. German and Finnish investors expressed interest in this relatively new but rapidly growing market.

Absolute return

Continued market volatility is generating stronger appetite for absolute return funds, with professional investors in several countries planning larger allocations. Dutch fund selectors with retail clients are particularly keen to see more hedge fund strategies repackaged in Ucits structures – a fund sector with assets under management of about €160bn, according to Lipper. Two-fifths of Finnish interviewees expect to increase their exposure to such ‘hedge fund-lite’ vehicles.

Regarding ‘traditional’ hedge funds, German investors say they are uncomfortable with the complexities of such products. However, Helsinki- based fund selectors are interested in Asia-focused long/short strategies with managers in Hong Kong and Singapore.

tom@ybc.tv

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