Investment Strategy: Reducing holdings in Italian government bonds

News item -

Despite the market rally that has been seen since late December, market sentiment remains fragile. The recovery in stocks is playing out against a background of slower economic growth in Europe and China and concerns regarding corporate earnings growth.

In this environment, the ABN AMRO Investment Committee decided to keep its overall asset allocation unchanged. The allocation reflects a neutral stance toward stocks, while bonds remain out of favour. Within alternative assets, commodities and hedge funds are favoured. A small shift in the bond portfolio has been instituted. In a further step toward risk reduction, the decision was made to reduce the position in Italian government bonds, with the proceeds used to invest in European covered bonds.

Global slowdown continues

While the US economy is expected to remain strong in the near term, a slowing in growth is expected later in the year. Europe has been in a slump for a while. Recent eurozone industrial and export data remain weak overall. German factory orders plummeted in December, while orders have been on a downward trend since the start of 2019. Italy also moved into recession.

Condition worsens in Italy

ABN AMRO has reduced its 2019 economic growth forecast for Italy to below zero. Not only is Italy being affected by the overall sombre economic climate in Europe, but there are also a couple of significant Italy-specific issues, including its budget deficit, which is expected to significantly overshoot the government’s targets. The Italian political situation also remains fraught.

Reduce holdings in Italian government bonds

With the outlook for Italy darkening, the decision was made to adjust the risk/return profile of the bond portfolio by reducing holdings in Italian government bonds and replacing them with European covered bonds. European covered bonds are typically issued by banks or mortgage lenders. They are considered safer than other types of bonds, given the significant collateral that is attached to the loan agreement.

This collateral is usually in the form of residential/commercial mortgages or public sector debt. Covered bonds are also subject to other conditions designed to protect bondholders. Overall, this shift in the fixed income portfolio improves portfolio quality by reducing holdings of lower-rated sovereign credit and increasing the allocation to higher-rated covered bonds.

Conclusion

The fourth-quarter earnings season is underway, and so far results have been mixed. In general, expectations had been revised downward, as analysts adjusted for slower economic growth, Brexit and the as-yet unresolved trade dispute between the US and China. The ABN AMRO Investment Committee is not negative toward stocks. Instead, the neutral allocation is viewed as the most flexible stance for acting quickly when visibility improves.

Delen