Last month’s political turmoil in Italy, pushed the 10-year yield significantly higher, from 1.75% on the 1st of May to 3.18% at its highest on the 29th of May. Yields in Spain, Portugal and Greece also moved in sympathy. The increase has been amplified by the proliferation of quantitative asset management strategies forced to trim their exposure as their risk model now price BTPs at a much higher volatility level. At the other end of the spectrum, the fly to quality pushed the Bund 10-year yield from 64bps on the 17th of May to the lowest 26bps on the 29th.
H2O view on Italian crisis following the interview by the new Italian finance minister Tria
“Tria has highlighted again the commitment to the Euro and stated that the focus will be more on the structural reforms than fiscal stimulus. He also underlined his commitment to the ongoing reduction of debt/GDP, which would also ensure that debt sustainability doesn’t come into question. The interview also pointed out the good economic fundamentals in Italy
This shows that pre-election campaign promises, and actual governance are not the same thing. The programme suggested by the populist government was already a watered-down version of those pre-election promises.
As during the Summer 2015 when the attention of investors was monopolised by a remote Grexit risk, soon to be followed by the real risk that was China’s devaluation, markets are today overly concerned with an even more remote tail event in Italy, while the significant risk lies with the consequences of an upward dollar trend in the context of out-of-phase business cycles between developed markets and the rest-of-the-world.
Italian sovereign bonds are in safe and stable hands, foreign investors holding 32% thereof (down from 41% in 2010), and non-EMU investors accounting for only 5% thereof.
Last month dislocations could prove to be very good entry points, especially in BTPs offering a high real yield (currently above 4% all included), negative supply over the next two months (as the central bank decided to reduce its issuance program for the year, half of it having already been completed), a significant short positioning originating from US hedge funds, and more importantly, fundamentals improving steadily.”
Our view on the fund’s strategy
The fund performance in May (-2.2% in EUR) didn’t come as a surprise, knowing that the spread convergence of the South European countries with Germany has been one of the PM’s major investment theme since the first European sovereign crisis in 2011. Although the theme was a bit less topical for the last two years, the fund was still short Bund and long several South European yield curves, including Italy. No doubt that Bruno Crastes will take the Italy events as a buying opportunity within the risk budget of the strategy. As he has always been and continues to be a strong believer on the Euro-zone solidity, he doesn’t see any remote risk of Italy leaving the Euro zone.
Despite this strong headwind the fund is still in positive territory on a year-to-date basis (+1.8% as of 31.05.2018), which validates the solidity of their investment process, i.e. positioning on 3 to 4 main macro themes translated into a diversified portfolio made of lowly correlated investment ideas and different time horizon. Among other things the fund benefited from the USD strengthening.
Going forward we expect the fund to be a bit more volatile according to the Italian headlines. Our opinion remains unchanged.[/private]