During the first two years of the Eurozone crisis, countries with a deep domestic investor base weathered market scrutiny longer than those with smaller local holdings. ECB statistics show that, at the end of 2010, Greece, Portugal and Ireland all had over 60% of their debt held by non-residents, while Spain and Italy had over half of their debt held by home buyers. Domestic investors are more likely to roll over their debt during periods of financial turmoil, lessening the pressure for sovereigns to pay back debts just when it is stressed for funds.
Domestic investors tend to be buy-and-hold and thus are a crucial component to keeping government bond prices stable. Though Japanese government debt is over 200% of its GDP, the sovereign nevertheless enjoys stable bond prices partly thanks to a strong retail investor base its domestic holdings make up 94% of its investor community. Even countries without a high rate of domestic debt holding can benefit from price stability when domestic investors concentrate on a particular part of the yield curve. Though only 32% of the Netherlands debt is held domestically, the concentration of Dutch pension fund holdings of 30 year government debt has kept long term financing costs low.
On top of that, domestic investors have more faith in their own governments than foreign investors. "Domestic investors are active taxpayers so they know overall the countrys situation better than foreign investors," says Anna Suszynska, head of international funding at the Polish ministry of finance. "And in most cases, domestic investors are buy-and-hold investors."
Domestic investors are also less likely to panic and sell in difficult times.
"Domestic investors have a better understanding of their home country and are less emotional when exposed to risk," says Luca Cazzulani, deputy head of fixed income strategy at UniCredit Research. "Foreign investors can be more reactive to political events. They respond more quickly and more irrationally."
In a crisis, domestic investors are also likely to turn to their sovereigns for reassurance. Just after Lehman Brothers bankruptcy in 2008, local orders for Polish government bonds denominated in euros or US dollars shot up to 15% from 3.5%. Local investors have continued to be supportive, making up 13% of the order book on Polands last $2bn dollar bond. Belief in the countrys economic strength has kept domestic orders coming. The opposite happened in Portugal, where 63% of its debt ownership is foreign. At the end of 2010, foreign investors liquidated vast amounts of debt.
"When a country runs into a lot of trouble, the domestic guys will always be the ones who will keep their existing bonds with the country," says Laurent Fransolet, head of fixed income strategy at Barclays Capital in London.
Governments with domestic liabilities can also better control their redemptions by raising taxes to service their existing debt. Thus, the benefits a government derives from its domestic base go beyond having a constant source of demand for its bonds.
All of this means that Eurozone governments must find ways to rally domestic support for their bonds to survive the crisis. Some countries are already doing this. Italy announced special BTP buying days where the buying fees for retail investors were waived. This funding strategy is not confined to peripheral economies. At the end of November, Belgium received orders for 1.39bn in the first three days of offering retail bonds maturing between December 2014 and 2019.
And domestic investors have been willing to back their countries. Barclays reports that non-bank Spanish investors have increasingly bought more sovereign debt since 2008. And bankers report that Italian domestic investors still have confidence in their governments ability to repay.
"The feedback we get from domestic investors is that they are still comfortable with government credit because the macro-economic fundamentals are still solid, so they dont think there is a solvency issue," says Cazzulani.
Loyalty, but not market access
Even so, sovereigns should not count on unconditional domestic support. Many domestic investors are very worried about their governments credit risk. French insurance companies, concerned about capital preservation, have sold off government bonds and are keeping the cash. As sovereign yields worsen, domestic investors might be forced to put their money into different products such as corporate bonds and emerging market bonds.
"More and more domestic investors are becoming risk-averse," says Ulrik Ross, global head of public sector debt capital markets at HSBC. "They will not change their investment parameters overnight, but they will be forced to re-think their investment strategy in the near future."
But countries also need immediate access to cash. Although sovereign investor bases are likely to become increasingly domestically biased in the next few years, mass buying from parts of the domestic investor base, such as retail holdings, will not happen overnight, making it important to continue to seek support from overseas investors.
"Governments need to be able to mobilise savings into investments in bonds," says Fransolet. "It is difficult to do that on a near term basis. The guys who have money and the willingness without having to mark to market would be sovereign wealth funds and the likes of China."
Healthy sovereign borrowers, moreover, cannot sustain themselves without courting outside investors. Attracting foreign investors on top of a core domestic base broadens demand and lowers a sovereigns borrowing costs. High volume trading also helps price discovery for a government bond. A varied investor base also brings about diverse maturity requirements, decreasing the risk of a sovereign having to pay up a large amount at one particular maturity.
"A debt manager wants a diversified and resilient portfolio, which means having a balanced investor base but also a healthy maturity profile," says Rob Stheeman, chief executive of the UK Debt Management Office in London.Stheeman characterises the Eurozone crisis as one, primarily, of a lack of market access and liquidity for some issuers. He adds that it is in times of economic hardship that governments particularly value the ability to sell bonds on open markets in all circumstances.