The Manager's Commentary - May 2011
No cucumbers please … just debt.
Cucumbers can be a vehicle for e coli and lead to human death while certain sovereign debt, especially that of Greece, can be the vehicle for catastrophic losses and the potential death of some banks. The title of this month’s commentary is referring to Germany’s potential import ban of Spanish cucumbers versus its apparent willingness to provide Greece relief from its debt obligations.
To understand German behavior one just has to look to the balance sheet of Deutschland’s finest banks. It is loaded with Greece ($34 billion), Spanish ($182 billion), Italian ($162 billion), Irish ($118 billion), and Portuguese ($36 billion) debt. The reason so much sovereign debt is held at some Euro banks is because the calculation of Tier One capital ratios under the Basel Accord did not require banks to allocate equity capital as an offset to any sovereign bond investment. To be clear, not all banks loaded up on these PIIGS but there were enough happy buyers to motivate countries like Greece to continually issue debt and keep the Sambuca dream alive.
Unfortunately, the after math of the leading edge levered dream turned nightmare, subprime mortgage invested CDOs, put the world’s largest economy into a recession that only octogenarians have experienced previously. With the removal of QE2 in process as well as moderating growth in China, many economists have been adjusting downward their GDP growth forecasts. As this becomes, if it hasn’t already, the prevailing macro view, owners of the debt of over indebted nations will be forced to extend and hope… which is not an investable strategy.
Nonetheless, this is the most likely scenario as the default of Greece would certainly make it very difficult for the other PIIG members to avoid such an outcome and create a cascading crisis of confidence which could be very bad for the global economy. A surprise step down in economic growth is our biggest worry. With yields of High Yield and Investment Grade at all time lows of 6.9% and 3.7% respectively a move to risk aversion could weigh on corporate spreads. We continue to look to hedge these exogenous risks by hedging the portfolio and keeping cash and cash proxies plentiful.
Two years ago this June the Pender Corporate Bond Fund was launched and we would like to thank those investors and advisors who have contributed to the funds success. While growth is good and can lead to business development and investment opportunities, the “partnership” model of strong communication, great clients, and a flexible credit investment strategy, is critical, in our opinion, to continued success.
Matthew Shandro
May 31, 2011