EUROWEEK: How do spreads affect your asset
allocation?
Lavastre, CDC: The current level of yields and tight spreads are penalising covered bonds versus govvies or other riskier assets. When we look at French covered bonds versus OATs we see little value and we are then compelled to change our portfolio allocation.
Juhasz, World Bank: For me the basis swap is very important as I have to look at everything from the dollar perspective. So even if European yields start to rise it does not necessarily mean that from a dollar perspective I will be better off. Actually, the basis swap could tighten much more, in which case I would be earning less.
Denger, MEAG: In current market conditions the portfolio allocation reflects a higher risk tolerance and higher yields at the short end and a lower risk with lower yields at the long end. In other words, we invest in covered bonds with higher spread volatility at the short end and bonds with lower volatility at the long end.
Juhasz, World Bank: The relative yield advantage of covered bonds, and especially core European covered bonds has declined, the proportion of covered bonds in our portfolio has declined as well.
EUROWEEK: What’s your strategy for coping with a potential rise in interest rates
Prokes, BlackRock: I wouldn’t be surprised to see the ECB becoming more dovish, to at least keep the front end in check. In reality we’ve had one rate hike already given that the Schatz went from zero to almost 25bp. So Europe is in a far worse position than the US to weather the emerging market and Asian slowdown, which means the Bund yield is not going significantly higher.
Denger, MEAG: It’s important to have a good balance of liquid investments in mid to longer maturities with higher yielding and less liquid bonds focused more at the short end as I can more easily hold these until maturity and replace them with new investments.
Prokes, BlackRock: I’m not anticipating a collapse in risk assets, but we could see some widening in a very, squeezed market but nothing too dramatic. I’m quite positive on the market overall for this year. If Bunds go to 2%, does it mean we will see a collapse in covered bonds senior spreads? Not really.
Juhasz, World Bank: As we have to swap our exposure to three month dollar Libor constantly, our interest rate risk is low. On the other hand, in a rising interest rate environment, swap spreads by default usually widen which has an impact on the relative value of the covered bonds so they might relatively underperform. So from a duration and interest rate perspective, we are okay but from a credit risk perspective we may see widening which we will try to hedge with additional swaps.
Prokes, BlackRock: With regard to the Fed’s tapering, the genie’s out of the bottle. But if you look at the global growth prospects there are still some headwinds. We may well see an emerging market slowdown in the second half, which could well weigh on the Fed’s thinking.