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Impact Investing

IPE special report May 2018

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In economic terms, France is in pretty good shape just now, with a pleasing combination of strong growth and low inflation. GDP growth looks set to again outpace that of neighbours Germany and Italy for the 4th year in succession. Although the budget deficit as a % of GDP has been higher than in Germany, the government has kept the purse strings tight and by 2001, the two countries should have comparable sized deficits. In 1999, the budget deficit was just over 2% of GDP, and is forecast to fall to around 1.5% next year. Unemployment, at 10% is high but here too the outlook is good, and the jobless rate should fall below 9% next year, having been as high as 12% in 1994.
The state of the government bond market is cause for further Gallic pride. French Government bonds (OATs) were much in favour with international investors throughout the late 1980s and into the 1990s, not only because of the convergence plays, but also because the bond market was big, liquid and easy to trade. The Banque de France had been reorganising the market since the mid 1980’s, creating a bond market with many similar supply and liquidity traits to that of the US Treasury market.
Today, 10-year OATs yield only 8/9 basis points more than Bunds, and many international investors do not differentiate between the French and German government bond market. At Swiss group Pictet, Jaeme Arguello says: “For us it does not matter which (bond) market, France or Germany, we enter. The yield differential is negligible, liquidity is very similar and so they are virtually interchangeable as far as we are concerned.”
Although liquidity has not been a problem in the French market – especially since the structural changes of the late 1980’s – many investors agree that it has been further enhanced by the introduction of the pan-European Euro-MTS screen based trading system which has brought in more market makers and improved transparency.
At CDC Asset Management, Roland Lescure says that EMU has not altered the way he and his team view French as opposed to any other European government bonds, although he suggests that if anything, EMU has been marginally good for OATs. He explains: “In a way, the process has consolidated their position near the top of the EU bond market pile. French and German governments are perfect alternatives – there’s certainly no question of differing risk between them. Our portfolios will continue to own more French bonds because there is no need for us to switch out just because of EMU.”
The onset of EMU may not in itself have had any specific effect on the workings of the domestic bond market, but it has changed the way some French fixed income investors look at their market. Jean-Pierre Grimaud, who heads up the fixed income desk at Credit Commercial de France (CCF), says that EMU has opened up new opportunities outside confines of the government bond market. He goes on: “Before EMU, our French fixed income exposure was very much concentrated in the government issues. Now however, we have a large credit market at our disposal and we have markedly increased the percentage of credit risk in our portfolios, at the expense of our domestic government bond market. Before EMU investors were insufficiently rewarded for taking extra credit risk in French bonds. Now however, with lower grade bonds offering 80-100 bpt pick-ups it is certainly much more remunerative and so more attractive.”
Offsetting declining demand for government bonds, supply is diminishing too as budget deficits are cut and government bond issuance continues to fall. And investors point out that the process of investing further and further down the credit scale will be slow and ongoing, both for the manager and their clients. As Lescure says: “Sure we are developing our expertise on the credit side, but our clients need to be convinced. Many of our clients are big institutional investors with relatively – compared to the US for example – low exposure to equities. For them, the issue of credit may come much later.” Caroline Hay

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