Italian and Irish bonds are leading gains among sovereign debt this year, followed by Belgian and Spanish securities, according to indexes compiled by Bloomberg and the European Federation of Financial Analysts Societies. Royal Bank of Scotland, Britain’s biggest government-owned lender, Germany’s Commerzbank (CBK) AG and France’s Credit Agricole SA (ACA) have reduced their investments in so-called euro-zone peripheral debt.

“There’s going to be some banks in some places that are going to have missed out,” said Steven Major, global head of fixed-income research at HSBC Holdings Plc in London. “Spain, Italy, Portugal -- and especially Ireland -- have done really well.”

Italian securities have handed investors a return of 11 percent this year, the most among 26 bond indexes tracked by Bloomberg and EFFAS as of March 1. Ireland’s debt has returned 9.9 percent, Belgium’s 3.8 percent and Spain’s 3 percent, the indexes show. Germany’s bonds, the European benchmark, have gained 0.2 percent, beating only Greece among their euro-zone peers. Italian two-year note yields fell below 2 percent for the first time since October 2010 yesterday.

RBS cut its holdings of Italian, Irish, Portuguese, Spanish and Greek government debt by 90 percent in 2011 while boosting those of German bunds, according to a Feb. 23 investor presentation.

Reputation Protection

Commerzbank more than halved its investment in Portuguese bonds in the two years through 2011 and reduced its Italian debt investments by more than a quarter, according to a Feb. 23 presentation. France’s third-largest bank Credit Agricole cut its Italian bond holdings by more than 50 percent, it reported the same day.

Banks are more concerned with protecting their reputation than bolstering profitability after European officials’ failure to resolve the region’s debt crisis spooked investors, according to Nicola Marinelli, who oversees $153 million at Glendevon King Asset Management in London.

“It is better to take the losses and tell the market your balance sheet is clean, because these are very dangerous times,” Marinelli said. “Even if those positions are not punishing you, the fact that you have them scares investors. It’s simply a matter of staying alive.”

Euro Summit

European finance chiefs gathered yesterday and national leaders meet today in Brussels for the 17th summit in the two years since Greece required outside aid to avoid a defaulting on its debt repayments, sparking the debt crisis.

The strong performance of peripheral nations this year is being driven by European Central Bank liquidity measures. The ECB offered unlimited three-year loans to euro-area financial institutions at the end of last year and on Feb. 29 as it struggled to contain borrowing costs and prevent the crisis from tainting the region’s larger economies.

The loans allow banks to borrow at the ECB’s record-low 1 percent rate and invest the funds in higher-yielding assets. The rate on Italian 10-year bonds has dropped more than 1 percentage point since the bank allocated its first tranche of loans on Dec. 21. The yield on two-year Irish and Portuguese debt has slid more than three percentage points.

‘Carry Trade’

Yields on the benchmark 10-year bonds of Italy were at 4.93 percent at 4 p.m. London time yesterday, while those of Ireland were 7.04 percent, Spain’s 4.84 percent and Portugal’s 13.76 percent. Bunds yielded 1.89 percent.

“The LTRO forestalls the deleveraging in the lending market but it just so happens that it set up a carry trade as well,” said HSBC’s Major. “But not everyone should be doing carry trades because you’ve got risk management concerns.”

Dexia SA (DEXB), the lender being broken up after losing access to short-term funding, reported a 2011 record 11.6 billion-euro loss on Feb. 23, citing concern about the debt of European sovereigns resulting in a “significant rise in risk aversion, especially from the U.S. investors.” Confidence in Dexia “was deeply affected,” it said in a statement.

MF Global Holdings Ltd. filed the U.S.’s eighth-largest bankruptcy on Oct. 31 after a wrong-way $6.3 billion bet on bonds of some of Europe’s most indebted nations.

Credit Ratings

As the credit ratings of countries such as Ireland, Portugal and Greece have been cut, those nation’s bonds have also become too risky to remain in many developed-market government indexes, reducing the number of institutions willing to buy the securities. Standard & Poor’s downgraded nine euro- area countries, including Italy and Spain, on Jan. 13.

Gareth Fielding, who helps manage $6 billion as chief investment strategist at Quantum Global Wealth Management, based in Zug, Switzerland, says his clients would rather accept returns of “low single-digits with no heart attacks” and avoid nations with a risk of default.

“It’s almost impossible for me to imagine a situation where we would be comfortable taking on long-term debt in those markets,” Fielding said. “There are times when you want to be aggressively seeking maximum return and there are times when you want to stay very close to your benchmarks. It’s better to be safe than sorry.”

To contact the reporter on this story: Lucy Meakin in London at lmeakin1@bloomberg.net.

To contact the editor responsible for this story: Daniel Tilles at dtilles@bloomberg.net.

http://www.bloomberg.com/news/2012-03-02/banks-miss-out-on-best-bond-market-gains-as-fear-trumps-greed-euro-credit.html

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