It is time to look back on the first nine months of the euro, and ask how the region's investors have coped with the sudden expansion of their domestic market. They have had to make both a quantitative and a qualitative transition. Equity fund managers used to the relatively underdeveloped stock markets of southern Europe have suddenly been confronted by a range of several thousand listed companies, all denominated in their own currency. Likewise, their colleague in bonds have faced a far greater range of borrowers to understand, and a more complete and detailed yield curve than their national markets offered.
Of course, Europe's asset managers always invested beyond their national borders. But they did so by the method of top-down allocation, taking views on macroeconomics and currency bets. This year, in contrast, they have had to seek performance through far greater attention to the individual securities on offer. For some asset-allocation strategists who previously concentrated on Europe's segmented markets, Emu has meant a new global focus on the relationships between the euro, dollar, and yen. Fabio Innocenzi, head of Europlus, the asset management subsidiary of UniCredito Italiano, observes that one effect of the disappearance of Emu members' currencies is that more of his clients' money is now invested outside Europe.
On top of the greater number of domestic-currency assets that need following under Emu, clients' expectations about the style of their investments have changed. Low interest rates, the growing mutual fund industry and the yield needs of insurance and pension assets mean that conservatively piling up government bonds will no longer do. Fund managers all over Europe report a shift to equity products and have had to get to grips with the pan-European phenomena of corporate restructuring, rising M&A activity, and the growth of new, information-based industries.
In bonds, the story of the year has been the surprisingly fast development of a euro corporate bond market. The region's companies have been encouraged by the large new investor community created by Emu to break their traditional reliance on commercial banks and come to the market. However, the message from the buy side is that the market isn't yet as wonderful as the euphoria suggests. Investment banks capitalized on the hype of early 1999 by bringing a torrent of deals to market. By the summer, they appeared to be forcing more and more corporate paper down the throats of weary buyers. Credit spreads widened, much to the anger of fund managers who had placed hope and money in the burgeoning asset class. According to the influential German investor DWS, in principle an enthusiast about credits, many debt deals weren't priced at fair value: the same corporates were paying higher spreads in the US.
In 1999, investment banks competed to arrange as high a volume of corporate issuance as they could. All underwriting houses believed the corporate market was embarking on years of expansion. All of them pushed for high league-table spots in credit paper, seeking to establish their credentials as the firms best qualified to receive corporate mandates. Next year, many fund managers hope the investment banks will act as genuine brokers, marrying the needs of borrowers and investors with greater care.
Among asset managers, there is great variation of method, and their fortunes in 1999 provide the first evidence of which approaches work best. The symbolic battle of old and new European investment styles is nowhere made more concrete than in the rivalry of Deutsche Bank and Dresdner Bank. Their respective fund-management brands, DWS and DIT, had directly opposed expectations of eurozone fixed-income markets as 1999 began.
Deutsche's DWS subsidiary believed that the traditional European game of adjusting your weighting on different parts of the government yield curve was running out of steam. With more and more investors becoming ever more efficient at spotting the best Bund and OAT maturities, DWS reckoned the smart money would seek to diversify into corporate, bank, or mortgage bonds, and apply a bottom-up style based on individual spread forecasting.
DIT, on the other hand, was sceptical about credits. It did not deny that the European fixed-income market was changing: it merely felt that the credit market would not come to genuine fruition for another couple of years. Those funds which, like DIT, have retained a duration-management focus may feel vindicated by the shortcomings of euro credit paper and the liveliness of government yield curves this year. However, as the corporate market gains in breadth and maturity, they will have to join the transition to a credit culture, including building up an international army of corporate analysts.
Although the investment tactics of European asset managers have quickly become transnational, their client bases have remained largely within national borders. This is thanks to the tendency of euroland institutional investors, such as insurance companies, to award fiduciary mandates to relationship banks; and the even more pronounced tendency of retail savers to trust their money to the same local bank branches that agreed their mortgages or overdrafts. But as Daniel Roy, head of asset management at French banking group Caisse des Dépôts et Consignations (CDC), reports, the situation is far from static. The more powerful asset managers are touting their product ranges to eurozone retail banks with more meagre capabilities. The game is beginning to go pan-European, through alliances.
Axel-Günter Benkner, head of fixed income, Deutsche Gesellschaft für Wertpapiersparen (DWS)
What has your bond strategy concentrated on during 1999?
Those funds that retained emerging-market bonds in them throughout the year have performed best. The highest capital gains were available in the bonds of emerging-market issuers, especially Brady bonds, and in certain currencies, especially the Polish zloty and the Hungarian forint. Bond funds performed poorly if they looked only at governments and traditional dollar and European instruments, because yields in the big currencies rose, while emerging markets came in strongly.
The currency component of global-bond funds was all about having a large position in dollars. Currency gains compensated for the rising yields in the bond market. That effect would have been even stronger in yen bonds, because the yen rose even more against the dollar than the dollar did against the euro. But with 10-year Japanese govies paying only 2%, the risk of being overweight yen bonds was very high.