While the International Monetary Fund has warned that Britain quitting the European Union would be a risk to global financial stability, one of the asset classes most vulnerable to the shock isn’t hearing the alarms, according to Allianz Global Investor’s sterling fund manager.
Peripheral euro-area government bonds are underpricing the risks of a Brexit, said Mike Riddell, the London-based money manager. Italian 10-year bond yields offered a premium of 136 basis points over similar-maturity German bunds Monday. Should Britain vote to stay in the world’s largest trading bloc, the spread could narrow to 115 basis points, but if the nation leaves, there is no limit to the potential widening, Riddell said. Betting on declines in Italian bonds is the most obvious way to trade this risk, he said.
“If the U.K. voted to leave the EU, as the second largest economy in Europe, then that does not send a good signal for the future of project Europe,” said Riddell. “If you think it’s political will that’s keeping the euro zone together then you can understand why peripheral government bonds would come under pressure. Within the fund, I don’t think you are being paid enough yield to compensate you for these risks.”
Italy’s 10-year bond yield rose two basis points, or 0.02 percentage point, to 1.49 percent as of 8:25 a.m. London time, while benchmark German bunds yielded 0.13 percent.
Riddell also said he has no positions in Europe’s peripheral corporate bonds. The 72 million-pound ($103 million) Allianz Sterling Total Return Fund that he took over management of in November is now 60 percent invested in sovereign debt with “very little” in high-yield corporate bonds, Riddell added. The Sterling Total Return Fund has returned 2.9 percent this year, beating 67 percent of peers. AGI is part of Munich-based insurer Allianz SE and manages about $500 billion.
IMF Managing Director Christine Lagarde said May 13 that if Britain votes to leave the EU on June 23 it is an international rather than just a domestic issue. A Brexit could lead to a “protracted period of heightened uncertainty,” triggering financial-market volatility and hurting output, the Washington-based lender said in its annual assessment of the U.K. economy.