Italy's election: From obstacle to opportunity for big bond investors

© Reuters. FILE PHOTO: Italy’s former Prime Minister Berlusconi smiles during the taping of the television talk show “Porta a Porta” (Door to Door) in Rome

By Abhinav Ramnarayan, Dhara Ranasinghe and Fanny Potkin

LONDON (Reuters) – Barely a year after French and Italian government bonds tanked on fears of a wave of anti-euro sentiment seemingly sweeping through Europe, the world’s biggest bond investors are viewing Italy’s election with equanimity and even some relish.

Italy goes to polls on March 4 and although anti-establishment party 5-Star Movement is riding high in the polls, a euro zone economic recovery has scotched political worries that troubled the market this time last year.

Indeed, some of the world’s biggest investors – who manage trillion euros of assets between them – are considering buying Italian government debt should there be any sell-off in the run-up to election day.

“The Italian election very much provides investors with a buying opportunity,” said Nick Gartside, chief investment officer at JP Morgan Asset Management, one of the largest investors in the world with 2.5 trillion dollars of assets under management. “If you take a step back and look at the health of the Italian economy and the euro zone economy overall, it adds to a compelling case for Italian government debt.”

JP Morgan AM believes Italian government debt is undervalued and the 10-year premium over Germany could go as low 90 basis points compared with the current level of about 145 bps.

PIMCO, the world’s largest bond investor, is neutral on Italy, said Nicola Mai, an analyst and portfolio manager for the fund.

“The Italian spread of about 150 basis points over benchmarks is actually decent carry relative to what’s out there because everything is so tight,” he said.


A strong euro zone economy, which outperformed the United States last year, has changed the game for investors.

Italy, the bloc’s third largest economy, is a key part of that: it is largely expected to beat official estimates of 1.5 percent growth in 2017 and earned its first ratings upgrade from Standard & Poor’s for at least three decades last October.

Those betting against the region got burned in the interim. Scottish hedge fund manager Hugh Hendry, a high profile seller of Italian bonds, was one of them and closed his fund Eclectica Asset Management late last year.

“From an index point of view, the most important thing is the possibility of a downgrade – and the positive economic backdrop makes this unlikely even if there’s a political shock at the election,” said Antoine Lesne, head of ETF strategy for State Street, the world’s largest passive investor with nearly $2.5 trillion of assets under management.

In addition, a tweak in Italy’s election law makes it harder for populist parties to come to power, and they have anyway toned down their anti-euro rhetoric.

Luigi Di Maio, leader of the anti-establishment 5-Star Movement which is leading opinion polls ahead of the election, said last week that pulling Italy out of the euro zone was no longer a goal of his party.

In any case, the possibility that an anti-establishment government comes into power is slim, said Mai of PIMCO.

“Our base case is some kind of grand coalition government, which is not a great outcome but nor is it a tail risk. It is ‘Italy as usual’ – a shaky government, not reform oriented,” he said.


This does not necessarily mean the run up to the election will be tension-free.

For example, the Italian/German bond yield gap widened by about 30 basis points in the last three weeks of December after the election date first emerged.

Though a good chunk of those losses have since been recouped, those are the sorts of bouts of volatility that many investors will be looking out for.

“We’ve reduced the amount of bonds we have in Italy by roughly half in anticipation of the election volatility and we’re looking to increase it again if that volatility comes to bear,” said David Zahn, head of European fixed income and Franklin Templeton in London.

“We still fundamentally like Italy we just think that tactically we wanted to reduce our exposure so that we have the ability to add more if we get a sell off.”

Even promises of increased spending in the run-up to the vote are unlikely to change the overall belief that Italy is on its way to reducing its high debt levels, said Patrick Barbe, who heads the sovereign team at BNP Paribas (PA:) Asset Management.

“Of course the market takes into account coalition promises, but we don’t expect any crisis like what was expected last summer,” he said.