Financial Times Europe - 31.07.2019

(Axel Boer) #1
Wednesday31 July 2019 ★ FINANCIAL TIMES 19

MARKETS & INVESTING


TO M M Y ST U B B I N GTO N

Irish government bonds are lagging
behind a rally in eurozone debt in a sign
that Brexit risk is seeping into one of
the quietest corners of the bond
market.

The gap between Ireland’s 10-year bond
yield and Germany’s — a gauge of inves-
tor perception of the riskiness of Irish
debt — widened yesterday to 0.57 per-
centage points, the most in more than a
month, reflecting a fall in Irish bond
prices.
Ireland’s yields remain below Spain’s
and Portugal’s and far below those of
Italy or Greece but a recent rise reflected
investor concerns that a British depar-
ture from the EU without a deal could
hit the country’s economy hard.
The UK is one of Ireland’s largest trad-
ing partners and the border between
Northern Ireland and the Republic of
Ireland remains a controversial flash-
point in Brexit talks between London
and Brussels.
Markets have grown alarmed by
Prime Minister Boris Johnson’s warn-
ings that October 31 is a “do or die”
deadline for Brexit with the pound tum-

bling to a two-year low this week. “You
can’t get away from the fact that the
most affected country in the eurozone
by a hard Brexit would be Ireland,” said
Lyn Graham-Taylor, a senior fixed-
income strategist at Rabobank.
Some investors have decided to steer
clear of the short-term risks affecting
Irish debt.
Mohammed Kazmi, a London-based
fund manager at Swiss private bank
Union Bancaire Privée, said he had sold
Irish bonds and replaced them with

Spanish debt in some of his portfolios.
“In light of the new cabinet’s comments,
we have replaced the Irish government
bonds held within our sovereign bench-
marked funds as Irish bonds continue to
price in very little hard Brexit risk.”
There are some powerful forces acting
against a more concerted sell-off in Irish
debt. Ireland’s economy has been
among the eurozone’s fastest growing in
recent years.
Dublin has succeeded in winning back
international investor confidence and
dramatically reducing its debt burden
since the financial crisis with the debt-
to-GDP ratio now under 65 per cent,
down from nearly 120 per cent in 2013.
Irish borrowing costs touched record
lows as recently as three weeks ago as its
bonds were swept up by a global rally
that has seen investors scrambling to
find bonds offering a positive yield. Irish
yields are below zero on debt with a
maturity of up to seven years.
“If the spread got much wider I think
you’d see people jumping in to buy,” said
Mr Graham-Taylor.
“But if the headlines with regard to
Brexit keep coming, I don’t think I
would go long Ireland here.”

Fixed income


Irish bonds lag behind eurozone rally


as investors weigh no-deal Brexit risk


R O B I N W I G G L E S WO RT H
A N D L I N D SAY F O RTA D O

Element Capital, one of the best-
performing major hedge funds since
the financial crisis, is sharply increas-
ing its performance fee and shrinking
the size of the fund to avoid falling prey
to the return-sapping bloat that has
affected many of its rivals.

The $18bn hedge fund founded by
Jeffrey Talpins, a former bond trader at
Goldman Sachs nda Citi how is one of
the industry’s brightest stars, already
charges a 2.5 per cent annual manage-
ment fee and 25 per cent of gains, far
higher than the industry average.
But by the end of this year, thefund
will raise the levy on any profits it makes
to 40 per cent, according to a letter to
investors sent out on Monday—
although it will trim its management fee
to 2 per cent.
It also plans to reduce the size of its
fund by 20 per cent. If redemptions
after the fee increase prove smaller than
that target, it will return a pro rata slice
of investors’ capital.
The changes represent an unusual
move for an industry where investors

are generally pushing money managers
to lower fees nd fewa funds ever will-
ingly relinquish any dollars committed.
Broadly, hedge funds’ performance
hastrailed behind badly in recent years,
souring some big investors. Nonethe-
less, some players areable to call their
own shots, thanks to their size, perform-
ance andinvestor demand for the lim-
ited space intop investment vehicles.
Elementis up 6 per cent in the year

through June, slightly ahead of the aver-
age performance of other “macro”
hedge funds, which try to profit from
broad cross-market shifts.
Element has averaged annual returns
of more than 20 per cent since 2005. In
the letter, Mr Talpinsimplied the move
was driven by a desire to optimisethe
fund for performance rather than size.
Many illustrious managers have
attractedpiles of investor money over

the years nly to find ito ifficult to gen-d
erate the eturns they didr arliere.
The increased heft made it harder to
be nimble in getting in and out of mar-
kets without making prices move
against them.
Whilefunds typically get a big slice of
any profits they make, the big fees they
receivefor managing the money means
that traders with sizeable assets under
management can ecome extremelyb
wealthy even with mediocre returns.
The move by Element bucks the over-
all trend in the industry, where charges
have continued to decline as investors
push back afteryears of poor perform-
ance and mounting cost consciousness.
As a result, the“2 and 20”fee struc-
ture isnearly dead.Funds hargec an
average anagement fee of 1.18 per centm
and performance fees of 14.45 per cent.
There has been more pressure on
management fees than on performance
fees, with funds justifying the latter as
an incentivising tool.
Only 28 per cent of the assets in the
industry are managed by funds charg-
ing at least 2 per cent, but more than half
are ubject to performance fees of 20s
per cent or more.

Asset management


Macro fund Element Capital to shed


assets and demand 40% fee on profits


Talpinsimplied the move


was driven by a desire to
optimisethe fund for

performance not size


Anti-Brexit campaigners protest at
a rally in Belfast, Northern Ireland

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C O L BY S M I T H— NEW YORK

Buying US government bonds could
soon become a more enticing prospect
for overseas investors as the sky-high
cost of protection against dollar
gyrations starts to recede.
For months, foreign investors looking
to buy safe US assets have faced a tough
choice: buypricey protectionagainst
swings in the dollar and earn tiny, even
negative yields — or grab higher returns
by leaving the risk of a weakening dollar
unhedged.
Since 2018, many overseas investors
have chosen the latter option because
so-called hedging costs have proven
prohibitively expensive. Now, that is
starting to crack.
“Clearly if we have [0.75 percentage
points] of Fed rate cuts over the next six
months, that would change the hedging
economics very meaningfully,” said
David Riley, chief investment strategist
at BlueBay Asset Management.
If, at the same time, longer-term bond
yields picked up from their lows, “then
that would be quite a powerful combi-
nation and make US assets more attrac-
tive to overseas investors”, he added.
Since the US Federal Reserve opened
the door to interest rate cuts in April,
the trade-weighted dollar has come
under pressure, sliding from its most
expensive levels in two decades.
The tilt towards easier monetary pol-
icy — coupled with extremely dovish

language from the Fed in the ensuing
months — has also fuelled expectations
of a further move lower in short-term
rates.
Markets are pricing in a 77 per cent
chance the Fed will cut its benchmark
interest rate by a quarter of a percentage
point when the central bank convenes
this week, according to futures prices
compiled by Bloomberg.
If chair Jay Powell complies, traders
are betting he will concede to at least
two more cuts by the end of the year.
Hedging costs have fallen as a result,
but they remain elevated enough that
many foreign buyers still face a loss
when buying US Treasury debt.
European investors with a three-
month dollar hedge now earn a roughly
minus 0.8 per cent yield on a 10-year US
Treasury, according to Bloomberg data,
compared with an unhedged yield of
2.05 per cent. Hedged Japanese inves-
tors earn minus 0.6 per cent.
Nikkei reported this week that the
world’s largest pension fund, Japan’s
Government Pension Investment Fund,

had already shifted course when it came
to protecting itself against currency
fluctuations. In the fiscal year ending in
March, the GPIF snapped up hedged
European and US bonds.
But according to Adam Cole, the chief
currency strategist at RBC Capital Mar-
kets, few are likely to follow in the
GPIF’s footsteps for now.
Rather, the Fed will have to cut more
deeply and over a longer period of time
if hedging costs are to move low enough
for more of them to put hedges back on
their foreign exposures.
In fact, he noted that the current
expected path of US rates brings
hedging costs only back to levels last
seen in early 2018, a time when Japanese
investors started going “naked” into
trades.
“This is not a normal easing cycle
because the Fed is expected to deliver a
quick burst of easing and then retreat to
the sidelines,” said Mr Cole. “It’s not
enough to see a wholesale increase in
hedging ratios.”
Another factor blunting the effect of

lower benchmark US interest rates is
that the Fed is not alone in cutting inter-
est rates this year.
True, the US has more room to cut
rates than other central banks whose
benchmark rates are close to or even
below zero but markets are “going into
a global synchronised slowdown in
rates”, as Jon Hill at BMO Capital Mar-
kets put it.
or instance, Mario Draghi, presidentF
of the European Central Bank, reiter-
ated last week his intention to ease
policy in the coming months.
One way for foreign investors to get
around the pain of currency hedging is
to buy lower-rated, riskier US debt —
giving them yield while allowing them
to insure themselves against destabilis-
ing currency fluctuations.
According to data compiled by Daniel
Sorid at Citi, investors in Japan, South
Korea and Taiwan can pick up any-
where between 0.16 and 0.53 percentage
points more yield than local 10-year
government securities by investing in
US corporate bonds rated single A, even
after factoring in the cost of a one-year
currency hedge.
Those bonds, subject to the same cur-
rency hedge, offer 0.48 percentage
points more in yield than 10-year Ger-
man government bonds.
But Mr Sorid warned that the “reach-
for-yield” dynamic brings about its own
risks.
“Foreigners’ continued reliance on
the US corporate bond market to
provide higher-yielding, long-duration
income has encouraged US companies
to binge on debt for as long as they
can,” he said. “That is of some systemic
concern.”

Foreign investors face easier


ride as price for protecting


against swings in dollar falls


‘The Fed is
expected

to deliver
a quick

burst of
easing

and then
retreat’

The US dollar
has been under
pressure, sliding
from its most
expensive levels
in two decades
Mark Wilson/Getty

Fixed income. urrency gyrationsC


Cheaper hedging costs take


sting out of US debt buying


N I KO U A S G A R I— LONDON

Aston Martin’s bonds are under pres-
sure after a rating agencydowngraded
its debt in a further test for the newly
listed UK luxury carmaker that last
week issued a surpriseprofit warning.
Moody’s cut the Warwickshire-based
company’s credit rating yesterday from
B2 to B3, at the very lower end of its
speculative grade ratings, with a stable
outlook.
The downgrade “reflects the lack of
progress in terms of volume growth and
profitability for 2019”, according to a
note from Tobias Wagner, senior analyst
at Moody’s,as well as the “weak and
competitive market environment”.
Shares in Aston Martin have fallen
since their high-profile listing last Octo-
ber. But the downgrade means that its
bonds are also taking a hit.
The yield on the armaker’s £285mc
bond maturing in 2022, which was
issued in 2017, climbed 0.48 percentage
points to 8.67 per cent as investors sold
the debt. Investors also moved out of the
company’s $400m bond with the same
maturity, sending the yield up nearly
half a percentage point to 9.82 per cent.
Both bonds have reached their lowest
price since January, according to
Bloomberg data.
The high-end car manufacturer last
week slashed its profit margin forecast
for the year from 13 per cent to 8 per

cent. It also cut the number of cars it
expects to make this year, from 7,100 to
6,200-6,500, blaming the impact of eco-
nomic uncertainty in the UK and
Europe.
The carmaker of choice for fictional
British spy James Bond as experiencedh
a tough 10 months ince it listed on thes
London Stock Exchange.
An economic slowdown and drop in
demand for high-end cars have battered
Aston Martin’s share price, sending it
plummeting 69 per cent since the initial
public offering.
“The market for high-performance
luxury vehicles is typically more resil-
ient to market pressures compared
to higher-volume premium brands,”
analysts at research firm CreditSights
said in a note. “The steep reduction
in... production levels at Aston Mar-
tin... highlights the level of market
weakness,” they added.
The credit downgrade by Moody’s did
not take into account the impact of a
potential no-deal Brexit, which could
further hurt the carmaker.
The chances of the UK crashing out of
the EU without a deal have risen since
Boris Johnson became UK prime minis-
ter last week andconcerns have sent the
pound to atwo-and-a-half year low.
Aston Martin’s prospects could dete-
riorate further, said credit research
company Lucror Analytics. “A negative
outlook could be considered in the light
of... a potential no-deal Brexit.”

Fixed income


Aston Martin


hit by credit


downgrade as


woes mount


‘The steep reduction in


production levels at Aston
Martin highlights the level

of market weakness’


Hedging costs to cool with Fed easing
US -year Treasury yield hedged for euro-based investors ()

Source: Bloomberg

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JULY 31 2019 Section:Markets Time: 30/7/2019- 17:52 User:stephen.smith Page Name:MARKETS1, Part,Page,Edition:EUR, 19, 1


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