Investors are still betting big on sovereign debt from struggling euro zone countries even as European banks offload their investments in an attempt to meet strict new capital rules.
Global investment firm Pimco, which manages some of the biggest bond funds in the world and has $1.97 trillion under management, has outlined its bullishness on Italian and Spanish debt in its latest quarterly outlook.
"We are overweight Italy and Spain sovereign debt in our portfolios, balancing the cyclical outlook, where we expect the ECB (European Central Bank) to maintain stability," Andrew Balls, managing director and head of European portfolio management at Pimco, said in client note on Tuesday afternoon.
"The size, liquidity and systemic importance of the Italian and Spanish markets make them our preferred source of peripheral risk."
(Read more: Why the euro zone bond rally may be ending)
Yields on benchmark government 10-year bonds from Spain and Italy - often seen as a proxy for risk in the euro zone - have calmed in recent months, dipping to around 4 percent. This is a far cry from the highs of 7 percent reached during market flare-ups in 2011-2012.
Back then, the European Central Bank helped out the euro zone's struggling lenders by launching cheap long-term loans, known as LTROs (long term refinancing operations). The banks used these cheap loans to buy government debt issued by their home countries -- even from struggling euro zone countries. This gave them a high return on the cheap cash obtained from the ECB and helped out countries' struggling to pay down their debt in the process.
But it now appears the happy times of the LTROs are coming to an end. With the ECB launching a quality review of the euro zone's banks last month, European banks are bus offloading riskier government debt to shore up their balance sheets. The Bank of Italy said in its November financial stability report that there were net disposals of securities by Italian banks in the third quarter of 2013.