Negative rates may be bringing misery to many investors, but not to all.
The man running the hedge fund operations of Danske Bank A/S -- the biggest financial conglomerate in the country to have endured the longest stint of negative rates -- says he’s found a trade that is unlikely to fail.
Exceptionally low yields have driven investors out of Nordic covered bonds. Only the shortest-dated notes still generate some interest. According to Michael Petry, head of hedge funds at Danske Capital in Copenhagen, that’s opened a rare window for relative-value investors who focus on spreads.
“Spread widening is getting closer and closer to Lehman levels in 2008,” Petry said. “We think they are very cheap.” With about $1.1 billion in assets under management, his specialty is fixed income strategies, particularly bonds and relative value. The fund earlier this year won the EuroHedge award for long-term performance in macro, fixed-income and relative value trades.
Denmark -- home to the world’s biggest mortgage-backed covered bond market -- has had a negative rate policy for the better part of the past 3 1/2 years. Most economists don’t see Danish rates crawling above zero until 2018 at the earliest. In Sweden, the central bank paints a similar rate outlook.
That’s pulled down yields on the region’s mortgage-backed covered bonds. In early 2015, Danish banks started offering 30-year bond-backed mortgages at 1.5 percent, hardly an appealing return for buy-and-hold investors.
But the devil is in the spread, it seems. And with the European Central Bank driving yields on euro-zone covered bonds even lower with its quantitative easing, the relative return on equivalent Scandinavian notes has started to look more attractive.
“We increased our position during spread widening, especially the last 10 to 15 basis points, because we think now it is very attractive,” said Petry. Preferred trades include picking up Danish 30-year mortgage bonds -- “we think they are very cheap” -- and then hedging the interest rate with Danish swaps, euro swaps or German government bonds.
Issuers are also seeing an opportunity in the widening spreads.
Jyske Bank, Denmark’s second-largest listed lender, said Monday its mortgage unit will begin offering covered bonds denominated in euros to minimize risks from exclusively refinancing in kroner. Anders Lund Hansen, group treasurer at Jyske’s mortgage unit, said he’s been getting a steady flow of calls from potential buyers since announcing the plan.
Investors “are looking for a solid issuer that offers a spread and where the curve isn’t too disturbed by the ECB,” Hansen said. “If you look at Nordic issuers, they offer a spread on top of the European issuers.”
Petry says he’s making money on the carry trade alone but expects the strategy to really pay off when the extreme monetary conditions and bank regulatory pressures now shaping markets start to abate. He says there are already some signs that’s happening, as lawmakers in Denmark argue in favor of a regulatory time-out.
“The timing is difficult,” Petry said. “But when you know that QE is going to finish, that is not the time when the market will normalize again. It will happen before ECB stops QE, and in my opinion it will happen way before the ECB stops.”