Will Greece crash out of the Euro? No one knows for sure. Would it really matter? Yes, though probably not as much as it did two years ago. Financial markets have shown a rather sanguine reaction to the twists and turns of the Greek saga throughout this year. Yes, there has been volatility. However, it has been fairly contained. Those expecting a major dip in peripheral bond market valuations (i.e. contagion) have been met with fairly muted moves. All the while, the Euro has proven to be surprisingly resilient. Of course, the future situation may evolve quite differently but it's looking somewhat unlikely.
Running parallel to the consensus view in financial markets that keeping Greece in should be still the goal, there is also a current of thought that sees Greece’s expulsion of the Euro as strengthening rather than weakening the single currency project. Irrespective of which view one takes on this, the one thing that all financial market participants agree on is that the pro-activist nature of the European Central Bank (ECB) has truly changed the rules of this game. To put it very succinctly, one should not mess around with a powerful central bank determined to do whatever it takes.
Despite this, many investors may be concerned about a potential repeat of the episodes of extreme volatility experienced in the 2010 to mid-2012 period. This is understandable. My personal view is that this would be a tail risk and hence highly unlikely to happen. However, one of the golden rules of investing is not to underestimate the potential for tail risks to surprise us.
Eurozone-based Investors
Any repeat of the market events of three years ago would call for the rolling out of safe-haven strategies. The most obvious course of action for Eurozone-based investors would be that of switching equity and broad fixed income holdings to the safety of German bunds. Yes, short- and even medium-dated German bonds are currently trading at negative yields. However, the likely strong capital appreciation (i.e. prices would go up) that would ensue would either offset or even more than make up for that. Besides, in a situation like this the overriding objective would be that of capital preservation. And so, paying a bit of a fee to a very trustworthy government for protection would be a fair deal. Moreover, if the worse were to happen (i.e. the Euro disintegrates), then one’s capital would be automatically redenominated into a currency that would strongly appreciate against all others. Not that bad a deal, even at negative yields.
UK-based Investors
GBP-based investors fearing for the instability of non-GBP holdings – or GBP-denominated equity ones – would have the option to move back into the safety of gilts. Here again, if the worse were to happen, GBP would also likely appreciate against most other post-Euro currencies.
Exchange-Traded Funds (ETFs) are very adept vehicles to quickly roll out an investment strategy of this kind. By simply tracking an index, investors can swiftly verify that they are buying the desired exposure and nothing else. Meanwhile, by virtue of its real-time trading in the stock exchange, they are instantly accessible at known prices. Last but not least, when the market goes on capital preservation mode, there would be little point in trying to outsmart it, which would strongly support going for a passive fund.
ETFs for Exposure to German Bunds
The most popular ETFs, as measured in terms of assets under management (AUM), that offer sole exposure to the German government bond market are the iShares eb.rexx Government Germany ETF (EXHA) and the Deka Deutsche Boerse EUROGOV Germany ETF (EL4R). They are physically replicated and track indices spanning out to the 10-year maturity segment. Further down the AUM scale we find the swap-based db x-trackers iBoxx Germany ETF (D5BB). Domiciled in Luxembourg, this ETF tracks an index which covers the whole maturity spectrum of the German government curve (i.e. including maturities over 10 years). These three providers, as well as UBS and Comstage, also have a range of German-centric government bond ETFs that offer exposure to thinly-sliced maturity segments.
ETFs for Exposure to UK Gilts
Investors seeking UK gilt exposure could consider the iShares Core UK Gilt ETF (IGLT), the SPDR Barclays UK Gilt ETF (GLTY) or the Vanguard UK Government Bond ETF (VGOV). The three are physically replicated. Those wishing to restrict exposure to the shorter segments of the maturity spectrum can look at the iShares UK Gilts 0-5yr ETF (IGLS) or the SPDR Barclays 1-5 Gilt ETF (GLTS).
