Positive economic vibes are prompting investors to ask: 'What are we missing?'
Published 02/02/2012 | 05:00
In recent weeks we have been on the road meeting clients and we were asked many thought provoking questions. Here are some of the most interesting questions we were asked and our answers.
Q: The prospects for the Irish economy, if anything, have worsened over the last six months yet Irish bonds have been on a stellar run. Why?
A: As you say, the run in Irish sovereign bonds has been quite phenomenal. The April 2013 bond yield has come in from a high of 22pc in July 2011 to stand at 5.4pc. At the long end, the October 2020 bond yield has come in from a high of 13.7pc to stand at 7.7pc.
There a number of reasons behind the move in our view. Firstly, the levels reached in July 2011 contained a large amount of euro area contagion premium and were not reflective of Ireland's situation even if one were to assign a decent probability of an Irish debt exchange.
As such, we wrote a note advising clients to buy Irish sovereign paper on July 22, 2011. The euro summit on July 21 removed much of the euro area contagion premium in the Irish market.
Secondly, the debt sustainability prospects for Ireland improved after the July 21 summit thanks to the lowering of the interest rate on the funds being transferred to Ireland by the EFSF.
Fourthly, momentum has played a large part in the recent move. The economic outlook, as you say, has gotten worse over the last number of months, but what is undeniable is that Ireland continues to stick to its austerity plans.
Ireland has shown an ability to adjust and this once again reflects the flexible nature of the economy, which saw the country run a current account surplus for the first time in 10 years in 2010.
The Irish story stands in stark contrast to Greece. As such, there have been numerous international commentators extolling the virtues of Ireland and in a couple of instances large asset managers revealing their positions in Irish debt. This has put a renewed focus on Ireland with many people asking, what am I missing?
The positive momentum in Ireland has certainly been helped by the NTMAs recent €3.5bn switch of January 2014 bonds for February 2015 bonds. This eases Ireland's funding requirement in 2014 and we expect that this funding requirement will be further eased by some deal on the promissory notes in 2012.
Q: Do you expect a similar run in Irish government bonds in 2012?
A: In general we have been a fan of Irish Government debt with maturities inside the EFSF window, so that is anything maturing before July 2013. We continue to like these bonds on an absolute basis and in particular relative to the yields on offer for short dated German bonds.
Outside of this date we see greater risk, but have been promoting Irish Government bonds of all maturities given the yields on offer. We expect momentum to remain positive in the near term, but given the recent run we are being more selective on entry points.
The Irish economy is extremely leveraged to US and euro area growth in particular.
If these economies prove more resilient than we expect, the long end of the Irish curve would be a decent place to play, especially given the yields on offer elsewhere.
Given the lack of availability of credit to SMEs, are business owners increasingly looking to private equity providers as a potential source of capital?
Notwithstanding the significant challenges that the overall Irish economy continues to face, many SMEs continue to achieve growth and have strong growth prospects.
This is particularly the case for export-led sectors (such as technology, software, biotechnology, pharmaceuticals, medical equipment and green technology) or for SMEs selling goods and services to global organisations based in Ireland.
If these businesses are to achieve their potential it is essential that they have access to growth capital (either debt or equity capital) to fund this growth.
There continues to be a large pool of funding that was raised by private equity firms between 2006 and 2008 which remains available for investment.
In the continuing absence of a fully functioning debt market, private equity is an increasingly attractive alternative for business owners seeking to access growth capital.
Not only do SMEs benefit from the business skills of private equity firms, in many respects equity is also a more sustainable source of growth capital than debt. NCB has strong relationships with many of the large-cap and mid-market PE firms with an interest in the Irish market and meets with them regularly to discuss investment opportunities.
Q: What are your top investment ideas for 2012?
A: In the short-term we like Irish bank debt which matures before July 2013. It's possible today to buy this paper which matures inside the EFSF window at yields to maturity approaching 13pc.
Our medium-term equity call is Kerry Group, which has a combination of good defensive qualities while achieving margin and volume growth.
Our target price is €32 which is a c.15pc increase on today's levels.
In the longer term we are beginning to get very interested in Irish commercial property.
While activity levels are currently very low, we are seeing specialist international investors beginning to explore the sector. Long term sustainable yields of 7-8pc are beginning to look very attractive to us with the right combination of location and tenant.
Brian Devine is the chief economist at NCB Stockbrokers