You may not have noticed it while on holiday this summer, but Italy is once again in crisis. Political risks make for an uncertain economic outlook. This week, we look at the top 5 bond funds with the highest exposure to the battered Italy debt markets.
Italy, the third largest economy within the Eurozone, is not known as a beacon of stability in recent decades. Not only economically, but also in the political arena. Since Mario Draghi’s government imploded last month after he lost the support of his right-wing coalition partners, Italians have speculated on whether Russian President Putin helped to remove the prime minister by putting pressure on the governing parties, which are allegedly closely linked to the Kremlin.
On 5 August, Moody’s confirmed Italy’s Baa3 rating, but downgraded the outlook from stable to negative. Although growth and budgetary developments in 2021 and early 2022 surprised the rating agency positively, risks piled up due to the economic impact of the war in Ukraine and domestic political developments. S&P left Italy’s rating unchanged at BBB but downgraded the outlook from positive to stable.
Nervousness but no market panic
Prime Minister Draghi’s resignation and the possibility that a euro-sceptical government could come to power in September, in addition to rising inflation and the ECB›s first rate hike, fuelled fears in bond markets.
The spread between Italian and German 10-year yields widened to almost 260 basis points at the end of July. As of Wednesday, August 24, Italian 10-year yields stood at around 3.67 percent while the German equivalent hovered around 1.37 percent. This spread varies but is elevated given the structural challenges the country has faced for years, such as a debt mountain of around 150 percent of GDP. Moreover, analysts fear that the next government will not adopt Draghi’s agenda of economic reforms and greater fiscal discipline. This could potentially jeopardise access to the European Union’s 200 billion euro Covid-19 recovery programme.
Nevertheless, Italian bond yields remain well below their levels during the euro crisis. This is mainly due to the belief among investors that, if necessary, the ECB will support countries that come under pressure from rising interest rates. By buying up the bonds of those countries, the ECB can, as it were, control the spread.
However, the question investors need to ask themselves is whether this can be assumed if the rising spread turns out to be an exclusively Italian problem and a euro-sceptical prime minister sits at the other side of the table. An illustrative example of what might happen then is Hungary. The 10-year yield on Hungarian government paper, also rated BBB, was 8.52 percent on Wednesday 24 August.
DPAM Bonds Euro IG fund
For this week’s Top 5, we look at mutual funds in various European bond Morningstar Categories including EUR Government Bond and EUR Flexible Bond, as per Dutch and Belgian fund classes. These five funds have the largest exposure to Italian debt.
The DPAM Bonds Euro IG fund consists of around 30 percent Italian bonds followed by an 18.2 percent allocation to Spain.
This actively managed fund measures itself against the performance of the JPMorgan EMU Government Investment Grade Total Return benchmark where both countries are ‹only› 21.6 percent and 15 percent. The underweight to German and French government paper is 11.3 percent and 20.4 percent respectively at the end of July 2022. The overweight to weaker but large Euro member states makes the credit profile riskier than the benchmark with 20 percent more in BBB bonds. The fund’s duration is shorter than the benchmark at almost 7 years. This strategy is managed by Ronald Van Steenweghen and Lowie Debou who are also at the controls of the DPAM Bonds Euro fund. This fund, which distinguishes itself by a 5 percent allocation to high yield securities, is also on our list. Van Steenweghen has been with the Brussels asset manager since November 2007, Debou joined in September 2016.
Neuberger Berman Euro Bond Absolute Return fund
The Neuberger Berman Euro Bond Absolute Return fund is managed by the experienced Patrick Barbe and Yanick Loirat who aim to beat their ICE BofA 0-1 Year AAA Euro Government benchmark by 3 percent to 4 percent over a market cycle. Both gentlemen came over from BNP Paribas. The managers here use dynamic interest rate positioning with a maturity range of -3 to +6 years and can take both long and short positions. In their most recent monthly letter to investors, the managers said they had recently increased their exposure to the periphery.
Italy’s political instability offered an interesting opportunity according to the managers. They expect the ECB to continue supporting Italy. The average credit rating within this fund is A- and it also has 12.3 percent in high-yield bonds. This gives it a completely different profile from the benchmark, which only holds AAA bonds with a maturity of less than one year.
As per fund class for the Netherlands:
as per fund class for Belgium:
