The $83 Billion Danish Fund Preparing for a European Debt Bubble

Denmark’s biggest commercial pension fund says Europe’s debt market is in the grip of a bubble and is avoiding bonds from the region ahead of Britain’s June 23 vote on European Union membership.

Instead, PFA has bought U.S. Treasuries and convertible Danish mortgage bonds to prepare for the market shock that might be triggered by this week’s referendum. The fund, which oversees $83 billion in assets, prefers debt from the U.S. because “it’s one of the few countries that’s not in a bubble,” said Anders Damgaard, chief financial officer at Copenhagen-based PFA.

“European sovereign debt is in a bubble because of the artificially low interest rates caused by quantitative easing,” he said by phone. “I can’t say how overpriced it is, but for us there’s no doubt that we’re looking at a bubble.”

The comments follow a dip in European yields last week, with Germany’s 10-year yield falling below zero for the first time in history. Bond prices, which move inversely to yields, have since declined as speculation fades that Britain might actually leave the EU. Most polls show a dead heat, while bookmakers favor a “Remain” outcome.

PFA says it expects Britain to stay in the EU. But it cautions against treating the vote as a binary event.

“If Britain stays, there’s no doubt we’ll see some relief,” Damgaard said. “If Britain leaves, there will be a two-year exit period, which we think would lead to high volatility, much like during the Greek debt crisis a few years back, with markets shifting between relief and new crises.”

Years of crisis upon crisis have provided some valuable lessons in how to gird for potential market shocks. Since Switzerland’s decision to send its franc into a free float at the beginning of last year, PFA has adjusted its portfolio to protect itself from a similar surge in safe-haven assets. Back then, Denmark’s euro peg came under a speculative attack as traders assumed the franc crisis would trigger a domino effect. In the event, the Danes prevailed but only after cutting rates well below zero, halting government bond sales and almost doubling foreign currency reserves.

Denmark pegs the krone to the euro in a 2.25% band

This time, PFA has increased its exposure to Danish kroner, which now make up about two-thirds of the total portfolio, Damgaard said. He declined to say what portion krone assets accounted for before the franc crisis.

“We’ve prepared by cutting down on risk and buying equity options so we can make money on a relief rally if Britain votes to stay,” he said. “We’ve also bought Danish assets, especially convertible Danish mortgage bonds, which we think are cheap and help mitigate the krone risk.”

But with less than 24 hours to go until voting starts, “it’s too late to buy protection,” Damgaard said. “One should have done that two-three months ago.”

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