Many investors are hoping that ex-ECB President Mario Draghi, Italy’s head of government since February, will succeed in reviving the sluggish Italian economy. However, this has not yet been reflected in an actual improvement in spreads and prices in the markets.
Paolo Bernardelli (photo) is Head of Fixed Income & FX and Manager of the 4.1 billion euro Epsilon Fund – Euro Bond.
© Eurizon
—
Eurizon bond expert Paolo Bernardelli is the manager of the € 4.1 billion Epsilon Fund – Euro Bond. He currently prefers corporate and emerging market bonds over government bonds. With regard to inflation, he expects a moderate development for 2022, but warns that it could become a problem if the current monetary and fiscal policy impulses lead to higher consumer prices. In this case, he also sees the risk of a reduction in monetary policy support from the ECB, as he suggests in the following interview:
Mr Bernardelli, what has changed for the Italian financial market since Mario Draghi was appointed Italy’s Prime Minister in February 2021?
Paolo Bernardelli: During the “Super Mario era”, the ECB recognized the need to avoid turning a macro crisis into a financial crisis, as it did with the hesitant response to the emergence of the subprime crisis in 2008. And even after he left at the end of 2019, the ECB continued to be very active in suppressing any market stress that could threaten global stability. That’s why the financial markets have had great expectations since Mario Draghi was appointed head of government in February. The hope is that it can help revive the sluggish Italian economy, which would mark a turning point for the slowly declining Italian economy. He has managed to form a government of national unity with a large majority that is unlikely to require new elections until March 2023. At the moment, this hope of the financial markets has not yet translated into an actual improvement in spreads and prices. The 10-year spread between Germany and Italy, a measure of the risks perceived by investors, is not far from the level it was at the beginning of the year. Reforms take time and energy to be implemented and financial markets need to see tangible signs that Italy is going in the right direction before giving Mario Draghi more credit.
Which investments do you currently consider attractive in terms of yield, duration and creditworthiness from the perspective of a bond investor?
Bernardelli: We live in a world with low or negative returns, with positive and rising inflation. For this reason, strategic asset allocation is important in a bond portfolio. Given a slow but steady rise in yields and a decreasing risk of default for companies, we currently favor corporate and emerging market bonds over government bonds. Thanks to the huge amount of money in circulation and support from central banks, we prefer low quality loans and the overall duration of the portfolios should be kept fairly low to reduce the risk of rising returns.
Where do you see the greatest risks for investors?
Bernardelli: It is always wise for institutional investors to think about what can go wrong, what problems could arise for their portfolios. Economic activity is currently expected to improve with stable yields and a temporary rise in inflation in the summer. The two opposite risks of this scenario are related to the pace of economic growth. Unless it continues to rise, we could face an increase in corporate default expectations and a decline in returns. The opposite is true if the rise in inflation does not turn out to be temporary. This could worry central banks, which may begin to be less moderate and less supportive of the economy.
How do you assess the current development of inflation – and what do you expect in the medium term?
Bernardelli: Inflation could be a problem. In the second half of last year we saw a sharp drop in actual and expected inflation due to the impact of the pandemic on the economy. With the combined effect of the reopening, monetary support from central banks, and fiscal support from governments, both economic activity and inflation rebounded rapidly in the first few months of 2021. The next few months will be very important. We assume that inflation, which could reach three percent year-on-year in Germany in the summer, will decline to an average of two percent or below next year. In such a case, the ECB will not be concerned and will likely remain fairly moderate. But there is also the possibility that the big monetary and fiscal stimulus could translate into higher inflation, in which case the risk of a reduction in monetary support from the ECB increases.
To what extent have you adapted your Epsilon Fund – Euro Bond to this?
Bernardelli: The Epsilon Fund – Euro Bond, launched in 2007, seeks to outperform the JP Morgan Euro GBI index within a 2.5 percent risk limit for Tracking Error Volatility (TEV). It is an actively managed fund that mainly invests in bonds from euro countries. The main adjustments the fund has made over the past few months have been to be underweight duration versus benchmark, with an important exposure to inflation-linked bonds.
All in all, what are the prospects for a euro bond portfolio over the next twelve months?
Bernardelli: Going forward, there will be greater interest among Eurozone investors in green bonds and ESG factors in general. Eurizon has adopted the principles for responsible investment that arose from the partnership between the United Nations Environment Program (UNEP-FI) and the UN Global Compact, with the Epsilon Fund Euro Bond using these ESG criteria as a core element of its strategy as it is a “qualifying fund under Article 8 of Regulation (EU) 2019/2088”. That is, he integrates ESG factors into the analysis, selection and composition of his investments and aims to build a portfolio that has an average ESG score higher than its benchmark and which respects governance practices. Because of this, it is well positioned to address the environmental and social needs of investors. “
Thank you for the conversation. (kb)
– .
