Italian Bonds Defy Rating Cut to Deliver World’s Best Returns: Euro Credit
Italy Defies Ratings to Deliver World’s Best Return
Marc Hill/Bloomberg
A visitor passes over a logo on the floor of the lobby at the Banca d'Italia in Rome.
A visitor passes over a logo on the floor of the lobby at the Banca d'Italia in Rome. Photographer: Marc Hill/Bloomberg
Feb. 23 (Bloomberg) -- Barton Biggs, managing partner and co-founder of Traxis Partners LP, discusses investment strategy and hedge fund issues. He speaks with Betty Liu on Bloomberg Television's "In the Loop." (Source: Bloomberg)
Italy’s bonds have delivered the best returns in the world since their rating was lowered by two steps as European policy makers accelerated efforts to stem the region’s debt crisis and offered Greece a second bailout.
Investors have made 7.7 percent, including reinvested interest, on Italian debt repayable in one year or more since Jan. 13, when Standard & Poor’s cut the euro-region’s third- biggest economy to BBB+ from A. That’s the biggest gain among 26 markets tracked by Bloomberg and the European Federation of Financial Analysts Societies. French bonds have earned 1.1 percent since losing their AAA grade on the same day.
Rating cuts, which last year helped drive Italian and Spanish yields to euro-era records, are becoming less important to bondholders after the European Central Bank said in December it would flood the region’s financial system with three-year cash through so-called longer-term refinancing operations. That encouraged investors to seek alternatives to record low yields on German bunds.
“The whole situation has changed a lot with the LTROs because this has stabilized markets in a tremendous way,” said Christoph Kind, head of asset allocation at Frankfurt Trust, which manages about $20 billion from Frankfurt. “Investors are making a distinction between the countries again, whereas last year we had big contagion.”
Declining Yields
The yield on Italy’s 10-year bond has dropped by 1.07 percentage points since Jan. 13 to 5.57 percent at 8:14 a.m. London time, from an average 6.02 percent in the two months following the Sept. 19 downgrade from A+. The securities lost investors 5.5 percent during that period, according to Bloomberg/EFFAS indexes.
Yields on German 10-year bonds, which have retained their top ratings, are 1.91 percent, after reaching a record low of 1.64 percent four days after Italy’s downgrade in September. The extra yield, or spread, that investors demand to own 10-year French bonds instead of bunds has almost halved since reaching a euro-era record of 2.04 percentage points in November.
“In the first half of last year, the market wasn’t really expecting rating moves,” said Justin Knight, a European rate strategist at UBS AG (UBSN) in London. “Now the market is more running ahead of the rating agencies in terms of pricing and investors are gradually starting to rely less on the agencies.”
Bund Losses
Bunds, which last year handed investors the biggest returns since 2008, have lost 0.6 percent since France and Austria lost their top grades from S&P. Italy and Spain have recorded the highest bond returns since Feb. 13, when Moody’s Investors Service cut their ratings together with those of four other euro nations.
Europe’s government debt securities are mimicking their U.S. counterparts, which surged after the country lost its top rating from S&P in August with the 10-year Treasury rate dropping to a record 1.67 percent on Sept. 23.
Downgrades are seen “more as an idiosyncratic risk, not as general default risk and that’s why the market is reacting in a different way,” said Kind at Frankfurt Trust.
Spanish and Italian bonds have rallied since the ECB offered unlimited three-year cash to the region’s banks in December. The central bank will offer a second round of loans on Feb. 29, after handing out 489 billion euros in December.
Demand for the region’s bonds also has been boosted by evidence of an economic rebound in the U.S. and Germany, stoking demand for riskier assets. The Standard and Poor’s 500 Index has gained 8 percent this year, after being unchanged in 2011. The Stoxx Europe 600 Index is up 8.3 percent in 2012, after sliding 11 percent last year.
Lagging Indicator
For Carlos Galvis, who helps oversee 46 billion euros as investment manager at Carmignac Gestion in Paris, ratings aren’t important to investment decisions as they tend to lag behind price movements.
“Credit ratings agencies are reactive rather than preemptive, so ratings shouldn’t play a fundamental role in your investment decisions,” said Galvis. Ratings companies “always lag the market’s perception of credit risk. This means that they don’t really affect our investment decisions,” he said.
To contact the reporters on this story: Lukanyo Mnyanda in Edinburgh at lmnyanda@bloomberg.net; Emma Charlton in London at echarlton1@bloomberg.net
To contact the editor responsible for this story: Mark Gilbert at magilbert@bloomberg.net.
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