Interview: Ralf Burmeister, DB Advisors

Ralf Burmeister, senior portfolio manager for covered bonds at DB Advisors, find attractions across the Nordic markets, but adds an important caveat.

What makes the Nordic covered bond markets special?

The region itself is clearly not at the epicentre of the crisis these days, but still, we would rather refer to national markets and individual issuers than simply making judgements about a region. But let’s take that expression for the sake of simplicity.

There are obviously things they have in common, namely solid covered bond legal frameworks, relatively good macroeconomic environments, and consolidated banking markets as well as experience from resolving a banking crisis back in the 90s. If you follow developments in banking regulation, one supervisory authority, for example, is requiring that banks hold more capital than is currently required under Basel III. That should also give some comfort.

Are the markets easily investible?

Looking at new issuance, we have seen quite a lot of supply from the Nordic region, again a lot of it denominated in euros, which gives euro-oriented investors a good opportunity to build up positions in decent size.

Furthermore, it is rather convenient trading covered bonds from the Nordics. We would not expect to experience real difficulties when selling larger blocks of that paper in the secondary market.

So besides the fundamental factors I mentioned previously, there is a positive aspect in terms of liquidity, which is obviously appealing for investors. I would like to point to current bid/offer spreads in that regard, which are among the tightest in the iBoxx covered bond index universe. Additionally, as an asset manager being measured in terms of mark-to-market, reliable pricing is always helpful in terms of evaluating portfolios and determining performance.

You make it sound like the Nordic Covered Bond market is the place to be…

Well, if you were to take yields and spreads as the only indicators of credit quality — yes, you would probably come to that conclusion. But at the end of the day it is the risk-return profile that counts, and in absolute terms of yield the market is not truly attractive to fixed income investors in search of an absolute return of, say, 4% or even more.

That should not be ignored given yield levels as measured by the relevant bond indices in the range of 1% to a maximum of 2.25% for longer maturities. Investing in these markets at today’s yields implies that investors would need to have a negative yield scenario in mind if they were seeking to achieve an absolute return target of 4% for several consecutive years.

So it ultimately depends on your risk aversion and your return expectations when determining the weighting of your portfolio in the Nordic region. In addition, given the large local domestic investor base which did not retreat in even very turbulent times and therefore always provided some kind of backstop to the market, liquidity should remain intact even in times of stress, so it might be justified being invested here despite such return considerations.

Furthermore, credit quality in general with regard to legislation and the banking sector may look above average.

Do you have any concerns about the housing markets?

Here, of course, we find differences between the various countries, but the trend in house prices has been upwards for quite some time, with one exception. But apart from this exception, key questions remain: Is there a considerable downside risk to the collateral backing the covered bonds I am invested in? Is a significant drop in house prices to be expected in the next couple of quarters? In this regard a variety of factors need to considered and closely watched, e.g. affordability indicators, construction starts, population growth, etc.

What about the rating situation?

As a matter of fact, ratings still are one of the cornerstones for investing in covered bonds, also for regulatory reasons. While it is up to investors to either follow the opinions voiced by the rating agencies or to come up with a judgement on their own, the absolute rating level of the market as well as the high rating stability demonstrated in the course of the crisis so far has been very attractive to traditional covered bond investors. So again, while absolute yield is one side of the coin, liquidity and relative stability also need to be taken into account.