Edinburgh-based Standard Life Investments is looking for carry instead of making yield bets on the view that the European bond markets will continue to be volatile over the coming months. Gregor MacIntosh, investment director, responsible for E1 billion in European government debt, says he is certain an economic recovery is coming. However, he says the yield curve will not change shape dramatically until there is some sentiment that there is a floor for interest rates--at which point he may reconfigure the portfolio.
Even if the fundamental economic picture is worse in Europe than the U.K. and U.S., there is more room for European government bond yields to go down, says MacIntosh. "U.S. and U.K. bonds have already beaten their lows and I'm surprised at how steep the curve is in Europe between 2s and 10s. I don't expect yields to back up in the near-term, but the market could be volatile," he says. So, instead of making yield bets, MacIntosh is looking for carry--or for the yield on the bonds to be larger than the cost of financing their purchase.
Currently, Standard Life is underweight two- and 30-year bonds. MacIntosh is more positive on the seven- to 10-year area of the curve. Although there is a lot of new issuance set to come in 10-year bonds from Germany and France, he does not expect it to negatively affect the market. Standard Life is underweight France, Germany and Italy, on the back of concerns about their deficit positions. It is overweight Spain, Ireland, the Netherlands, Belgium and Austria.
Separately, Standard Life has been aggressively long index-linked bonds, but MacIntosh believes they have become rich based on the eurozone's inflation outlook. He says they have been reducing allocation a little, but inflation-linkers remain an attractive class, because pension funds and other investors with inflation-linked liabilities keep the asset class well bid. Finally, MacIntosh says inflation should rise when the ascension countries--Poland, Hungary and the Czech Republic--enter the EMU.
Standard Life Investments, which manages £24-25 billion in domestic and overseas government debt and corporate credit, uses the Merrill Lynch EMU Direct governments one to 10-year, over five-year and over 10-year indices as benchmarks for its E1 billion European bond portfolio.
