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Rock and rollover

The European Union bailout has not changed our stance on the financials sector in Europe.

Lower interest rates and extended maturities of loans to Greece, Ireland and Portugal are positive developments but there are some elements of the package that we view as negative.

In addition to cheaper funding for Greece, Ireland and Portugal, the package involves some positive innovations. The European financial stability facility will be able to buy bonds in the secondary markets to help to stabilise them, removing this role from the ECB.

This is a big development because it is a first step towards a Eurobond. The EFSF is a pan-European, guaranteed fund that can now help to finance national bond markets in certain strict circumstances. The EFSF will also be able to lend to countries in order for them to recapitalise their banking systems.

This is almost a Tarp-like structure and should lower the global systemic risk of the current crisis. This is innovative and another positive change.

The negatives concern the private sector’s voluntary rollover of existing debt to longer maturity bonds. In net present value terms, this amounts to an economic loss for bondholders. The EU has been very clear this only applies to Greece and is an exceptional case.

However, while the rollover is voluntary, the fact that the authorities have encouraged it sets a precedent for the rest of the euro-denominated government bond markets.

Further, the scope of the EFSF has not been enlarged. It still has a limit of euro 440bn to deploy, which is enough for Greece, Ireland and Portugal but not enough for Spain and Italy. Spain and Italy are themselves reasonable contributors to the EFSF and so they are unlikely to be able to draw on it easily.

Despite these negative considerations, we cannot be too harsh on the EU authorities responsible for this package. They need the political capital in place before they can deploy the economic capital to create a safety net for the euro system.

In the long term, further fiscal integration can act to solve the crisis. Total euro-denominated government debt as a percentage of GDP is around 85 per cent, which means a fiscal union can work, provided the euro area electorates agree.

The Neptune European opportunities fund has made some modest changes.

It retains the underweight in banks and has become more underweight in insurance. We are also now underweight the euro, from a neutral position. It has reduced the industrials sector weighting to neutral and has added to consumer staples, buying back Nestle. The beta of the fund has been lowered to 0.95.

Rob Burnett is investment director and head of European equities at Neptune Investment Management


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