Treasury Today Country Profiles in association with Citi

Flight of the cautious investor

Leading hedge fund managers are betting on significant sell-offs of German government bonds in the coming months. Something that can truly be called extraordinary.

Fulcrum Asset Management’s Gavyn Davies argues every hedge fund’s analytical model is signalling the German bond market is too expensive. However, he strategically tempers this by saying he doesn’t see the capital flight from Eurozone countries continuing to push yields down indefinitely.

But, inevitably, some fund managers have chosen to be less hedged in their opinions. Certain market players – previously reluctant to face the full force of German and ECB peak at the merest hint of a bet against the bund – are now setting their stalls firmly in one direction.

Hedge fund managers already shorting German bonds include John Paulson of Paulson & Co, (market anointed guru), and Bill Gross, Chief Investment Officer of the world’s largest bond fund, Pimco. While GLG Partners’ chief investment strategist, Jamil Baz, argues, “The crisis has not even started”.

It’s undeniable that bund yields have fallen to all-time lows this year; the ten year yield hit a low of 1.13% on 1st June 2012. However the ten year benchmark yield has been fluctuating both up and down. And a number of investors remain in a state of anticipation that there will be a full Eurozone rescue, eventually.

Inevitably, this will still weigh down on Germany’s creditworthiness. So where is the flight taking investors?

The answer is towards US treasuries. They are finding themselves on the portfolio guest list of many a nervous fund manager in search of safe diversification. And that’s despite them rocking up to the party virtually empty handed in terms of yields.

This significant flight has left yields for treasuries and TIPS (Treasury inflation protected securities) deep in negative territory. They are estimated to have fallen into a range of 1.25 – 3.0%.

According to Dan Shackelford, Lead Manager for the Core at T Rowe Price, the global shortage of high-quality sovereign debt has left treasuries seeming more attractive than the main alternatives, among them the bund and Japanese government bonds (JGBs).

“We’re in another ‘risk off’ period, and the US dollar is still perceived as the global safe haven, even though we are facing the prospect of a decelerating US economy”, Shackelford says. On the demand side, J.P. Morgan recently reported that purchases of sovereign bonds by mutual funds and banks in the US and the Eurozone this year have already exceeded the total for 2011.

And some investors are keeping their chins up in the knowledge that US corporate bonds have not sold off. Spreads may have widened but it has been a passive widening, with corporate yields not falling as much as treasuries. Shackelford argues this suggests there is no immediate concern about credit fundamentals.

But, whether US treasuries are just a temporary stop-off point or a long-term resting place for the safety seekers, the hope is that neither stint will leave the proverbial investor shaken or stirred.