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The Catalan factor in European bonds

The Catalan factor in European bonds


Could Cat bonds soon refer to debt issued by an independent Catalonia as well as to catastrophe bonds? Or, in that event, would catastrophe and Catalonia be essentially synonymous anyway?

Bond markets certainly seemed to abhor the notion of secession, with Spain’s 10-year bond yield jumping by 18 basis points in the days following Catalonia’s independence referendum – which had been ruled illegal – before retreating a little. This still marked the worst week for Spanish bonds in three months.

The slight recovery late in the week reflected both cooler rhetoric and a successful auction of Spanish bonds – the first since the Catalan vote – which had come to be viewed as a gauge of investor sentiment towards the country.

‘Since the outcome of the Catalan referendum, the market has priced in more political risks in Spanish bonds and the yield on Spanish bonds increased compared to German bonds to a six-month high, whilst also underperforming its Italian peers,’ commented Kim Liu, senior fixed-income strategist at ABN Amro.

A Spaniard in the works

As evidence of the anxiety ahead of the bond auction, Liu noted that it was ‘quite unusual’ to hear Spain’s economy minister Luis de Guindos claim that ‘demand for Spanish bonds will be high’.

‘Usually, government officials refrain from making such comments to try to ease market concerns,’ observed Liu. ‘Nonetheless, the words of Mr de Guindos proved to be right,’ as demand did prove strong.

‘The favourable auction results were greeted with some relief in the market,’ said Liu. ‘Spanish sovereign bonds instantly outperformed German and other peripheral bonds, whereas Spanish bonds trailed these countries before the auction ... [but] we remain cautious and see upward risks to Spanish bond yields as the Catalan turmoil still has the potential for further escalation.’

Credit rating agency DBRS was more optimistic, stopping short of downgrading Spain in a report at the end of the week, but highlighted the risks. ‘Catalonia’s bid for independence has progressively escalated political tension over the past few months,’ the agency said.

The passive route

For investors who are concerned about the outlook for Spanish government bonds, there is little to distinguish the main broad European sovereign debt ETFs.

The iShares Core Euro Government Bond ETF and the Vanguard Eurozone Government Bond ETF each have a 13.8% weighting to Spain, with both employing a Bloomberg Barclays index. The Deutsche Eurozone Government Bond ETF, meanwhile, tracks an iBoxx index but has only a marginally different 13.1% exposure to Spain.

The Vanguard fund is the cheapest of the three at 0.12% – although it is tiny with only £4.5 million of assets – followed by the far larger £1.5 billion Deutsche and £985 million iShares ETFs on 0.15% and 0.2% respectively.

Those willing to make a duration call have more levers with which to control their Spanish exposure – although care is warranted over the choice of product. The £812 million iShares Euro Government Bond 1-3 Year ETF, for example, has a 29% weighting to Spain with all the remainder in Italy.

The £418 million SPDR Barclays 1-3 Year Euro Government Bond ETF, on the other hand, has just the standard 13.9% in Spain as it adheres to a Bloomberg Barclays Treasury index rather than the different methodology of the Bloomberg Barclays Government Bond index used by iShares.

It is the reverse situation at the far end of the duration spectrum. The £290 million iShares Euro Government Bond 15-30 Year ETF has only 9.7% in Spain, compared with just over 13% again for the £4.5 million SPDR Barclays 10+ Year Euro Government Bond ETF.

The two SPDR ETFs also have lower total expense ratios of 0.15%, versus 0.2% for the iShares funds. iShares is, though, the only provider to offer a London-listed Spanish bond fund: the £350 million iShares Spain Government Bond ETF again costs 0.2%.

Of course, investors unwilling to let their country exposure be determined by an index can also turn to active managers. Fortunately, active funds in the Bonds – Euro sector have tended to add value: the average manager has generated positive risk-adjusted returns over both the past one and three years, with personal information ratios of 0.97 and 0.02 respectively.

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