Looking beyond Greece

Greece has represented a worry, but one that has been well-factored into investment equations. This is part two of a Super Review asset allocation roundtable.

Mike Taylor, managing editor, Super Review: Now I know Chris that you favour European sovereigns and corporate bonds, but given what's been going on in the world lately I just wonder how much comfort that's going to give super fund trustees in Australia, given that they're inevitably a very cautious bunch of people. So if you want to talk directly to super fund trustees, there's going to be nervousness there, what's the reassurance there on the sovereigns?

Chris Diaz, head of global rates and portfolio manager, Janus Capital: Well I certainly think that one of the areas of market we like in Europe is in peripheral Europe which are the southern European countries that did exhibit some level, do have some credit risk premium, if you will, built into their yield levels as their yields are somewhat higher than that of Germany. We certainly went through the Greek drama and I learnt more about Greek politics than I ever wanted to know. But we believe that to be an isolated situation that the fundamentals of the country are not comparable to some of the larger countries, nor do they represent the systematic importance to the Eurozone.

So I think we have come to the conclusion that that's an isolated incident and we find value in countries like Spain, like Italy, and frankly believe that the European central Bank (ECB) will complete their quantitative easing program as outlined and will ultimately be successful in compressing yield levels to those of the risk free, namely Germany. We look at what we would classify as success of the Fed's QE program in the US and think that the playbook is going to be still very similar for Europe.

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MT: Justine, you're dealing fairly closely with fund trustees, you know exactly how cautious they can be and a bit confused from time to time. What's your take?

Justine O'Connell, consultant, Frontier Investment Advisers: Well I mean our view is somehow similar from a Greece perspective, in that certainly at this point in time versus say if that had happened a couple of years ago, the peripheral countries are certainly in a better position to deal with the Greece issue than they were a number of years ago. It is really an isolated, to a certain extent, event and the impact on the sort of broader Eurozone area should be relatively limited, and the EU and ECB have a lot of firepower and are ready to kind of deal with issues that might arise.

I think our view has really been that Greece, and that's based on a lot of the work that our capital markets team has done in terms of travelling Europe and speaking to a number of the IMF and a number of different organisations there, is that Greece is actually very important from a geopolitical perspective. And that's kind of been a driving force behind keeping Greece within the Eurozone. And from I guess an investment opportunity set, we obviously delegate that to fund managers, but we're broadly comfortable that that situation is relatively isolated from the Greek issue perspective. Although it is a risk.

CD: Well see we're talking about peripheral Europe. Look, there is no doubt that the latest version of the Greek crisis has had a direct impact on the volatility we're seeing in peripheral bond markets and also in corporate bond spreads. That's fairly clear. But there were other things going on at the time. Obviously we saw a significant sell off in markets which was largely technically driven, given the fact they'd rallied so hard. But what is interesting to note this time around, if you look at the volatility we saw in those peripheral bond markets, it's significantly less than what we've seen in previous versions of the Greek refunding crisis, if you go back to the previous two times it's occurred.

Our view is it's largely reflective of the nature of the investors we see now. Close to 80 per cent of Greek debt now is held by institutions, largely those major European based funding institutions. So the private investors are far less exposed to Greece as an event, which means that obviously you're not going to get in a direct collateral sense the same degree of fear of impact on balance sheets, particularly in the European bank sector, we were worried about the last time it happened.

The other thing to note is the fact that Greece represents close to three per cent of eurozone GDP. So the crisis was more about contagion risk as opposed to any impact Greece could have in terms of impacting the longer term outlook for European growth. And I think what we've certainly seen out of this latest resolution is it's certainly a strong commitment by the eurozone to push through these reforms, and you've certainly seen it with the agreement in the Greek parliament to adhere to those changes. So you know, what that really means is the liquidity crisis that we were facing with the Green contagion has abated for now. We're starting to see spreads narrow back in. Is Greece still a risk in a solvency sense? Yes, of course they still have hurdles in terms of being able to service that debt.

But we've certainly seen – I think every time we go through these events, we see potentially greater commitment by the authorities to find a resolution. And we're seeing in that process less volatility in the market. What that really means for investors, we had a spike in volatility. Potentially that could give rise to opportunities. We've certainly seen it with managers out there who see opportunities in some of those markets, to take advantage of the volatility. Broadly speaking, the eurozone is largely a project at this stage. There's a lot of commitment for it to continue it its current form. But you need to be mindful of these events which occur and we certainly are in terms of where you see opportunities out there. We don't invest directly, we have managers who do that for us and obviously we look for managers who are proactive in that space and see the opportunities when they arise. But we're certainly not suggesting that you should be out of the Eurozone completely, no.

Stephen van Eyk, investment consultant: I will say this, it's been three times that Europe's had a single currency in history and every single time it's been Greece that's mucked it up. In fact I think back in Roman times, you had to have a certain content of gold in your coins in the single currency and Greece actually cheated and put less gold in the coins, which mucked the whole thing up, and so they've ended up getting kicked out. So I just wonder whether you can go for the trifecta and they're going to get kicked out anyway.

But having said that, there's probably things going on underneath in fixed interest markets and the world generally that are kind of a bit more important as we go forward. I mean I don't think growth's picking up any time soon, I think it's a long-term thing. So every time that's happened and you've got disappointing results, all the markets have rallied on it as if it's a terrific thing. But sooner or later if you keep getting that, it's not a terrific thing because nobody's making any money, and therefore you get to a point and I think that that point's probably going to come up.

I also think the volatility of markets are often a warning that in six months or 12 months time you're going to maybe get something bigger, and that's happened a lot of the time in my experience. You get a skirmish and then in fact it happened prior to 2008, in about 2006 and 2007, then you got the really big one. Everyone said it's okay, it's okay. But I think one of the things that's happening is yes, you've had the easing monetary policy which obviously it couldn't go into the economy because it wasn't growing fast enough, so it went into financial markets and it pushed them to where they are and everybody's chased higher yield and ever higher risk situations to try and get the yield up and obviously that's starting to run out.

The other thing beneath it all is actually the matter of savings in the world, because obviously the higher the savings, the lower the real interest rate and vice versa and obviously in the Western world people are retiring so their savings are less, but you've had the offset of massive Chinese savings because after 20 years of exporting, et cetera, people started to save  a lot of their income because they had no social security, health benefits or anything like that and that has burst out around the world and it's in every market around the world. In America first with their bond markets and their property markets, obviously in Sydney at the moment people have identified with all of that. So it's made up for the savings that weren't in the rest of the world and that's coming to an end in the next five years.

I think we're going to continue to get volatility, that'll be sort of [be] bubbling underneath [and] that savings will start to dry up, real interest rates at some point will be forced up, at the same time as everybody's said that easing monetary policy will come to an end. So there's kind of potential for a lot of volatility in the next five years and at the moment, I happen to think Europe's probably the best place to invest in equities in terms of relative valuations and stuff like that. But I think people have got to adjust portfolios to really take care of volatility. You can make money out of volatility, whether it's a manager that you've just said Greg that takes advantage of these episodes and buys in and rides it up, maybe one day it doesn't ride up, but you've got that, you've got mutual funds. There's a whole lot of things that you can do in portfolios to...

Greg Michel, senior consultant, JANA: There has been a lot of market volatility recently and you need the investment flexibility in order to be able to take advantage of the opportunities that the volatility creates. Real bond yields are particularly interesting at the moment. Real bond yields are also at historic lows in most developed markets and in some have been negative. The view is that the large level of global quantitative easing has driven the chase for yield and the sharp fall particularly in real bond yields. But its not just QE, there is also a lot of savings out there looking for investment yield. There is a lot of cash out there at the moment chasing assets and this investment money is not limited geographically. It goes global looking for yielding assets. In terms of bonds it means that yields can remain at below normal levels potentially for longer.