Taking a leap of faith on Irish recovery

One of America’s most successful fund managers likes to pick off investment prospects which are overlooked by the pack — and Ireland is reaping the benefit of his foresight, writes Kyran Fitzgerald

He has yet to celebrate his 40th birthday, yet Michael Hasenstab is already viewed as one of America’s most successful fund managers with a 10-year return batting average of over 12% a year.

Hasenstab stands out for another reason. Since the middle of 2011, he has invested increasing amounts of money in Irish government bonds, to the point where his company, Franklin Templeton, holds around €8.5bn of our national debt — more than 10% of the total committed by private lenders.

Ireland has been on a bit of a roll among overseas investors. In late July, we re-entered the primary bond markets, with over €5bn in bonds sold, 60% of it to overseas investors, easing fears of a big financing gap emerging in early 2014. The yield on benchmark 10-year bonds has fallen to around 4.5%, reflecting this growth in confidence.

In recent weeks, Paris-based ratings agency Fitch raised the country’s rating to a respectable BBB-plus, while bond issues from the ESB, Bord Gáis and Bank of Ireland were heavily oversubscribed.

Both the ESB and Bord Gáis have, as a result, restructured their finances, lowering their borrowing costs in the process.

This should eventually be passed on to customers.

As the credit-worthiness of the sovereign is restored, the cost of finance for Irish corporate and bank borrowers should be reduced.

Speculation on an Irish return to the long-term bond markets is building, though such a move remains contingent on agreement on a deal on our vast legacy bank debts.

Assumption about such a deal is written into the price of our sovereign paper. Credit for this turn of events should go in part to key domestic actors, in part to the ECB’s determined president, Mario Draghi, the man who has assumed monetary leadership after a long period of drift, but also to key market players such as Hasenstab, ready to take an early punt on an Irish recovery. Other so-called “bottom fishers” include Bank of Ireland investors Fairfax Holdings and Wilbur Ross.

Hasenstab is no reckless gambler. Since the 1990s, he has built a reputation as an extremely astute bond market operator, relying on what amounts to a contrarian approach to investment. In 2010, he was named top global bond fund manager by Bloomberg Markets. In recent years, he has been bullish both on Asia and much of eastern Europe.

Franklin Templeton had almost $750bn under management as at mid-2011, with the funds divided equally between bonds and equities. Hasenstab personally is responsible for the company’s emerging markets and global bond funds.

One has to ask why more fund managers have not followed Hasenstab in making a positive call on an Irish recovery and whether our return to respectability in the sovereign debt markets is accordingly, built on perhaps fragile foundations. The fact Franklin Templeton has continued to build its holding of government stock is itself a positive.

National Treasury Management Agency boss John Corrigan sought this week to address concerns about a possible dumping of stock by such a large holder when he pointed out that “any large exit of Irish government debt would probably be self defeating”.

Corrigan also noted the Moody’s “non investment grade rating for Irish government debt remains a “big impediment” to attracting in Asian investors.

These remarks help to explain the relatively lonely status of Hasenstab’s funds in relation to Ireland.

Donal O’Mahony, chief bond strategist with Davys, offers a more in-depth explanation. Irish yields soared after Moody’s downgraded the sovereign’s paper to junk bond status amid fears of a major haircut of private creditors.

As a result of the Moody’s decision, many pension funds and insurance companies ceased taking Irish paper. In effect, their rules prevent them from investing in “junk” bonds.

The fact that the other ratings agencies have not so rated Irish bonds so lowly has counted for nothing.

The investment managers take their cue from the weakest link. This, frustratingly, remains the case, with Moody’s rating Ireland three notches lower than the other agencies Fitch and Standard & Poor’s. Franklin Templeton operates under no such restriction, allowing Hasenstab greater room for manoeuvre.

The Irish cause has not been helped by the stance adopted by the country’s life and pensions sector which combined hold a mere €450m out of around €88bn in Irish government paper. O’Mahony believes that the pensions industry is shooting itself in the foot by investing in low-yielding German bunds. This, in turn, has contributed in no small part to the problems being experienced by Irish pension schemes.

Were the pension funds to invest in higher yielding but secure paper, the liabilities of the funds would be reduced accordingly.

In O’Mahony’s view, a Moody’s upgrade would open the way for continental European and Asian funds to invest in Ireland. This, with a change of attitude on the part of the pensions industry, might combine to push yields and returns even lower. This may explain why Hasenstab continues to invest in Irish paper, despite the big drop in yields — and potential returns — since mid-2011.

Hasenstab has provided some interesting insights into his thinking on bond investments generally.

Over the past two years, he has been bearish on both the dollar and the eurozone. He remains concerned about the failure of US political leaders to tackle the fiscal deficit and is also about Ben Bernanke’s policy of monetary easing which he argues was necessary in 2008-09, but has been too long drawn out.

He likes to pick off investment prospects which are overlooked by the pack. Recent picks have included Ireland and Hungary. Earlier, he placed big bets on Poland and South Korea.

Greece, however, is viewed as a lost cause.

He is a fan of volatility and regards periods of panic as a wonderful opportunity to buy. One guesses that he has quiet contempt for the fund manager pack

He still believes in the Irish recovery — and for that we should all be grateful, even if, to date, the biggest beneficiaries of his vision have been his clients rather than the hard-pressed citizenry of Ireland.