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Bond funds reveal euro holdings as contagion looms

At least seven global bond funds revealed top 10 holdings in peripheral eurozone debt at the end of September, according to Trustnet, as Ireland’s financial woes accelerated towards its recent bailout.

Italy and Spain dominated the holdings, rather than Greece and Ireland, which have received a bailout from the IMF and the European Union – in Ireland’s case, the European Financial Stability Fund.

Managers also avoided Portugal, which has a deficit of almost 10 per cent of GDP and is struggling to pass budget cuts. 

Large portfolios which hold Spanish or Italian debt include the £753m Newton International Bond, the £423m F&C Global Bond, the £339.2m Threadneedle Global Bond, the £337m Old Mutual Global Strategic Bond and the £199m Henderson Overseas Bond funds.

Investors fear demand for Spain and Italy’s debt may decrease, even as their deficits supply the market with more debt. This dynamic would push down the value of the debt and push up yields.

Italian yields are already 4.2 per cent and Spanish yields 4.8 per cent, according to the Financial Times. Portugal’s is already 6.8 per cent.

 The yield, which tends to set the interest rate on new government debt, is already close to the 5 per cent interest rate quoted for the IMF and the EFSF.

Spain last year had a budget deficit of 11 per cent of GDP, or about €120 billion (£100 billion). Unlike Portugal, it has passed severe cuts which are set to reduce the deficit to 9 per cent of GDP, or roughly €100 billion.

 Spain is proposing further measures to cut the deficit to 6 per cent of GDP, or €65 billion, in 2011. However, its budget projections assume growth of 1.3 per cent next year.

Lombard Street Research already regards Spain’s growth figures as too optimistic, given public spending cuts and unemployment, which is running at roughly 20 per cent.

Spain’s growth was non-existent in the third quarter, but LSR expects it to dip in the fourth.

Spain’s banking sector is also receiving emergency funding from the European Central Bank, which limits the amount it can lend to the government and to the private sector.

Moreover, Spain has guaranteed more than 10 per cent of all lending from the EFSF, according to the fund’s site, or €52 billion out of a total of €440 billion.

If the EFSF contributes three quarters of the Irish bailout, as the EU did for Greece, Spain would be liable for €6-7 billion of the debt in the event of a default or a restructuring.

Spain’s liabilities would increase by a similar amount in the case of a Portuguese bailout.

The prognosis for restructuring is currently uncertain. Irish institutions are already agreeing voluntary restructuring with their creditors, according to announcements by Anglo Irish Bank on November 19 and 22.

Overall, Paul Brain, the manager of the Newton International Bond fund, says Spain is not growing fast enough to stomach the budget cuts required. He has sold out of Spanish debt entirely.

Dave Chappell and Martin Harvey, who co-manage the Threadneedle Global Bond fund, say the Italian situation looks somewhat superior. Like Brain, they have stuck with their holdings in the country.

Italy ran a deficit of just over 5 per cent last year, or €100 billion. It has already settled on budget cuts of more than €25 billion to reduce the deficit this year and next.

If it bails out Greece and Ireland, the EFSF also does not have the resources to bail out Spain or Italy

Its banks are also in better shape and have greater resources to fund the private sector and the government.

However, Italy’s EFSF liabilities are double those of Spain. Its deficit will also still supply the markets with more debt, potentially at a time of falling demand.

Overall, the managers conclude, neither Spain nor Italy would seek a bailout purely on the basis that their funding costs from the IMF and the EFSF would be lower.

If it bails out Greece and Ireland, the EFSF also does not have the resources to bail out Spain or Italy. Their GDP each exceeds €1 trillion, according to the IMF.

The managers say they have 5 per cent in Italian government bonds maturing in two years, 5 per cent in five-year bonds maturing in five years and 1.5 per cent in 10-year debt.

If Portugal appears to require a bailout, they say they will review the position.

At the end of September, the other bond funds’ exposure to the euro periphery was lower, within the limits of their top 10 holdings.

The Old Mutual Global Strategic Bond fund had a 3.8 per cent top 10 position in Spanish government debt, which bears the higher risk of the two.

The F&C Global Bond fund had a 3.6 per cent top 10 position, which it retained at the end of October.

The Newton International Bond fund had 3 per cent exposure to Spain outside its top 10, but has sold out of its holding.

In Italian government debt, the Henderson Overseas Bond fund held a 5.2 per cent top 10 position, the Threadneedle Global Bond fund 5.1 per cent and the F&C Global Bond fund 4 per cent and the Newton International Bond fund 3.1 per cent.

Of the smaller funds, the £39.4m Swip Global Bond Plus fund held 4 per cent and the £36m Fidelity International Bond fund 1.9 per cent.

Only Newton and Threadneedle were available for comment.


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