Lowest EU Yields Pose Risk as KBC Czech Unit Looks Abraod

The Czech bond rally that has reduced yields below those of Germany is boosting risks of losses, the nation’s third-biggest investment company said.

CSOB Asset Management AS is recommending clients diversify from Czech bonds by buying stocks as well as higher-yielding debt from Poland to southeast Asia, Chief Executive Officer Jan Barta said in an interview in Prague yesterday. The unit of KBC Groep NV oversees $8 billion in assets.

Czech bond rates are set for a record yearly decline as an economic recovery helps the government slash borrowing while regulation forces local banks and some pension funds to buy the securities. The yield on 10-year debt traded at 0.72 percent by 3:40 p.m. in Prague, three basis points below AAA-rated bunds and the lowest level in the European Union. Comparable notes from neighboring Poland are trading at 2.56 percent.

“There is very little room for any further gains on Czech government bonds,” Barta said. “For investors who don’t have to hold them for regulatory reasons, it’s pointless to take the risk of a spike in yields in exchange for such a small return.”

Demand for Czech debt, which Moody’s Investors Service rates at A1, its fifth-highest grade and a step above Poland, is also supported because the public-debt level is half of the EU average and the central bank has pledged to keep its main interest rate at 0.05 percent until at least 2016.

Polish Bonds

Czech bonds have returned 9.7 percent this year in koruna terms, with the 10-year yield down a record 180 basis points, or 1.8 percentage points. Investors have made money on the debt since Bloomberg began tracking the data in 1999 except in 2007, the last time yields fell below bunds.

The rate on the 10-year bond may rise above 1 percent next year, according to Ales Prandstetter, chief investment strategist at CSOB Asset Management, who accompanied Barta at the interview. Polish notes will benefit from expectations that the central bank will cut its benchmark borrowing cost, already at a record-low 2 percent, to stem a drop in consumer prices, he said.

“Our portfolio managers now certainly invest in foreign bond markets more than before,” Prandstetter said. “Poland is experiencing its first-ever deflation, which may trigger more monetary easing.”

Yields on par with Germany, Europe’s largest economy, are damping the appeal of Czech debt for foreign investors, Dmitri Barinov, a money manager overseeing $2.6 billion at Union Investment Privatfonds GmbH in Frankfurt, said by phone Nov. 14.

‘Technical Factors’

Czech banks, some of the best-capitalized in Europe, have been flooded with extra liquidity since the central bank a year ago sold 200 billion koruna ($8.9 billion) in the currency market to weaken the exchange rate and avert deflation. They have invested some of that in central bank deposits and sovereign bonds.

The government scheduled no bond sales for November and December after Finance Minister Andrej Babis said in August the 2014 budget deficit will be lower than originally planned. It hasn’t sold any Eurobonds since 2012 as koruna yields are lower.

While such “technical factors” keep driving demand for Czech bonds, the yields are lower than the country’s economic “fundamentals” would suggest, according to Prandstetter.

“I don’t think the Czech Republic is as creditworthy as Germany, not least because Germany is much bigger,” he said. “A fairly small increase in yields may wipe out several years of returns. This could happen if the government steps up debt issuance, inflation returns or risk aversion spikes.”

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