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Greece lightning

Work is under way to address the problems with Greece and European governments are scheduled to meet to debate the crisis on May 10.

However, this makes for a tight timeline, considering the country has large bond issues that fall due on May 19 and May 31, analysts at Charles Stanley noted. But while global attention is focused on Greece, issues over the amount of debt in others countries is also under scrutiny, playing havoc with the outlook for government debt in general.

Certainly, UK gilts appear out of favour with many investors, including specialist bond managers. Simon Thorp, head of fixed income at Liontrust, says he is not positive on gilts at the moment but he has been surprised at their resilience in light of the Greek crisis, holding up even as Greece was being downgraded. Still, he believes to buy gilts at this point investors would need to be in the double-dip camp and he feels there are greater opportunities elsewhere, such as high yield corporates.

Colin Harte, director of fixed interest at Barings and manager of the group’s absolute return government bond trust and global bond fund, is also negative on gilts at this stage.

However, he says investors should not be worried that the Greek situation is one which could occur here. The UK is not vulnerable to default.

Instead, gilts look unattractive because of inflationary threats. Harte noted there are great deal of red herrings about sovereign debt issues at the moment.

He definitely sees that Greece is primed to default, with Portugal likely to be next and while Spain is slightly better off, there remains a threat there as well. However, the debt issues in these countries are very different to the problems in the UK.

It is not necessarily a case of how large the debt but how a government can address the problem and Greece, Portugal and Spain are hampered by the fact that their debt is denominated in euros. Countries like the UK, US and Japan issue debt in their own currencies, meaning, if need be, they could go to the printing presses to aid repayment. Such action may result in higher inflation but not default, says Harte.

He says his absolute return fund is currently short UK gilts as he does expect inflation to rise and become more volatile in the near term. He is also favouring very short duration bonds in the US, two to five-year Treasuries and he is considering going short on Japanese government bonds.

Overall, that leaves his fund negative duration and net short with alpha plays occurring via currency bets at the moment. In his long-only global bond fund, Harte said he is underweight duration and defensively positioned. Underweight gilts, his biggest positions are in German bonds.

In his retail portfolios, Harte says he has walked away entirely from any exposure to Greece, Portugal and Spain, although some of the group’s institutional bond portfolios still have weightings to the regions due to their presence in the overall benchmark.

BNY Mellon is taking a slightly different approach, noting that despite the negative newsflow, there is some appeal to be found in Greek bonds.

Paul Brain, manager of the Newton international bond fund, says: “After all, they yield more than those of any emerging market government which has leant on the IMF for support, or has gone through a restructuring, but furthermore, the Greek government has actually put in place plans to reduce its burgeoning deficit.”

Greece has also been promised an abundance of near-term EU/IMF support and with these supports in place, Brain says he would be more comfortable holding Greek government bonds than, for example, those of Portugal, Italy and Spain, which have yet to address their issues.

Last week, S&P cut both Spain and Portugal’s credit ratings to AA and Arespectively.

Harte does not disagree that Greek bonds could be considered attractive but he contends the situation is impossible to predict.

“It is hard to assess the risk/reward scenario here. Ultimately, it is a political call. If you believe Greece will not be allowed to fall, then at this level or even 150bps higher, Greek bonds look attractive. But it is a complete bet, a crap shoot. There is no rational way to assess what will happen.”

Brain says the best way to offset the risk associated with Greek bonds is to be underweight the euro. More broadly, he noted, should Greece be forced into a bond restructuring, an applicable precedent will have been set for those other deficit-laden eurozone countries. “Therefore, we will be steering clear of Portugal, Spain and Italy while markets continue their test of nerve with Greece.”

Thorp does not necessarily believe Greece will default on its debt as there is a threat it could have a spiraling effect that leads global markets back to the situation they were at during the credit crisis.

Charles Stanley analysts also foresee grave contagion issues if Greece defaults, noting its downgrade to junk has already created ripples.

They pointed out that ECB rules hold that only bonds rated as low as BBB minus may be used as collateral against liquidity. “We do not know whether Greek banks will be forced to pay back liquidity to the ECB and if so, will they be forced to call in credit to business, at a stroke killing off much of the country’s remaining commercial activities? In addition to an economic crisis, Greece now faces an equally severe credit crunch.”

The Investment Management Association reported strategic and global bonds were the top two best selling sectors for retail investors in March, although UK gilts were not a popular area and for institutional investors, it was the worst selling sector. Considering the events in April and the growing Greek crisis, it will be interesting to see what happens when we see April’s sales stats.


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