Flee ‘Safe’ Sovereign Debt, Says Hasenstab
The man who made some of the boldest contrarian bets in the bond market last year has a new message for investors: get out of supposedly safe government debt now, before it is too late.
"The downside of being early is very limited. You're not participating in any 11th-hour rallies, but it's not like you're losing money," says Michael Hasenstab, who oversees $175bn in bonds for Franklin Templeton, the Californian asset manager.
Rising interest rates mean losses for holders of long-dated debt, and he says that if it were not for the Federal Reserve's bond-buying program, US Treasury yields would be "higher, meaningfully higher".
"The worst has happened and we haven't fallen into a deflation trap. As things either stabilize or get a little bit better, it's hard to imagine deflation coming out of nowhere." Without that, he says, "US 10-year yields below 2 per cent just don't seem consistent with the US economy."
Mr Hasenstab is anything but a bleating Cassandra. The softly spoken 39-year-old has the air of an academic, while he has built a remarkable investment record through a combination of patient optimism and almost preposterous confidence. Last year funds controlled by Mr Hasenstab practically cornered the market for Irish and Hungarian debt as part of aggressive bets that both countries would recover from the financial crisis.
On the risks to "safe" government debt, Mr Hasenstab is not forecasting when rates will rise. But he has adjusted the $66bn Templeton Global Bond Fund he manages in anticipation. For instance, in emerging markets such as South Korea he has been buying short-dated bonds paying 2.5 to 3 per cent, with the prospect of gains from currency movements over time.
"They have an interest rate advantage, so if we look out five years, the value of the Korean won relative to the value of the dollar will probably be higher because we're just flooding the world with dollars," he says.
So while the typical effective duration – a measure of sensitivity to interest rates – for global bond mutual funds run by peers is five or six years, his is less than two years.
Mr Hasenstab likens this to a previous bet on the Japanese yen, where Templeton was very early on its negative view of the currency. "It didn't work for years and then when it happens, it happens pretty big, pretty quickly. You can't come in after it starts happening."
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Franklin recently became the largest private holder of Irish sovereign bonds with almost a tenth of the market, raising fears that prices would tumble as soon as he stopped buying. This month, however, Ireland sold 2.5 billion euros of five-year bonds paying 3.3 per cent, a sign of relative financial health. There was 7 billion euros worth of demand, with 90 per cent of the buyers coming from outside the US.
"This recent access to the market I think finally closed the door on a lot of the naysayers," says Mr Hasenstab.
Some investors are less sanguine. Myles Bradshaw, a portfolio manager at Pimco, says that Spanish bonds offer better value. "Getting the budget deficit down now depends on growth, but it's a small, open economy that needs global growth to pick up, and I can't really see that. So Ireland will need more austerity and I think that will be difficult to implement."
Mr Hasenstab says that his exposure to emerging markets means that he is already exposed to countries such as Spain and Italy, even if he does not own their bonds directly, due to the consequences of another crisis.
"If there's a tidal wave coming from a credit event in Italy, then it doesn't matter how great your thesis is on Malaysia, the ringgit's going to get blown up," he says.
But while Mr Hasenstab forecasts recession for Europe, he still thinks it will hold together, and is more upbeat about the global economy as the effects of quantitative easing by central banks in the developed world are exported to emerging markets.
Indeed, he remains patiently optimistic on one of the other great investment debates of the moment. "There's a lot of perma bears on China who believe that everything there is a Ponzi scheme and it's all artificial. I don't believe that."
He argues that overbuilding in China has helped the country avoid bottlenecks. "Brazil tops out at 4.5 per cent growth because they don't have the infrastructure, such as the roads, the rail systems necessary to grow faster without overheating.
"Were some developments, toll roads, or railroads built that shouldn't have been built? Sure, but I think that's not seeing the forest through the trees. Our sense is they will grow into that infrastructure over the next 10 years," he says.
That belief, he says, is a combination of the big macro themes, with the informed local knowledge behind such bets as Ireland, or Hungary when they are hated by the market. "Really, you can only do so much behind a Bloomberg screen."