Greece becomes roadblock for European investment

Mounting tensions over the situation in Greece and the potential for a default or exit from the eurozone are in part holding back institutions from investing in an otherwise positive story for Europe.

Executives at money management firms and asset owners also said they are keeping a close eye on day-to-day developments in the country, despite sources saying an exit by Greece from the monetary union — a so-called Grexit — is unlikely.

“We're monitoring the situation in Greece, and its effects on the eurozone, very carefully,” said Christopher J. Ailman, chief investment officer of the $191.2 billion California State Teachers' Retirement System, West Sacramento. “Overall, we think Europe is a potentially attractive market but the Greece crisis continues to be a major concern, as it has been for the past two years. It remains a factor in our decision to maintain a relatively light footprint in Europe, preferring a home-country bias for the portfolio.” Details on allocations were not available by press time.

J.P. Morgan Asset Management's Maria Paola Toschi, Milan-based global market strategist, said the firm thinks the case for investing in Europe and European equities is strong. However, “many investors are waiting to better understand what happens in Greece before deciding to increase their exposure. That is a drag on the process of reconsidering reinvestment in Europe,” she said.

A spokeswoman for Norges Bank Investment Management, manager of the 6.8 trillion Norwegian kroner ($894 billion) Government Pension Fund Global, Oslo, said the firm is “monitoring the situation in Greece.”

Sandeep Bhamra, London-based client adviser in J.P. Morgan Asset Management's endowments and foundations team for Europe, the Middle East and Africa, said clients “continue to monitor the situation, especially European investors.”

Money managers have had little or no exposure to Greece since its reclassification to emerging market status by index providers in 2013. With Greek government officials locked in negotiations with the country's European creditors over reforms, the Greek economy officially in recession following two successive quarters of GDP contraction, and a crowded pipeline of repayments to the International Monetary Fund and the European Central Bank over the summer, concern is increasing.

BNP Paribas Investment Partners has no exposure to Greece. “We do have some peripheral (Europe) exposure but that is more short-dated, and we take the view that the ECB should be able to contain any problems there,” said Colin Harte, London-based portfolio manager and strategist within the multiasset solutions team. “Most of our exposure is to higher quality European debt — we have been a bit more defensive there.”

“We have tended to shy away from direct investment in Greece for some time,” said Paul Griffiths, London-based chief investment officer, fixed income and multiasset solutions, at First State Investments International Ltd. “We are concerned about the knock-on effects of problems to the broader European, and global, story. The question is: Is the market, and are we (as investors) being complacent?”

“The issue is no longer about whether the debt can be repaid in full, since market consensus says Greek debt is unreasonably high,” said Tapan Datta, head of asset allocation at Aon Hewitt, in London. “The original target was to have (the) debt to GDP (ratio) below 120% by 2022; it is currently around 180%.”

Rather, he said, the question is how Greek debt is restructured, “whether it is disorderly, there is debt relief or extensions (to payments). Also, if no deal happens and a Grexit (occurs), what will be the contagion, and what could follow? I would have put a Grexit at low probability a month ago, but now it is something clearly on the radar. But it is not terminal yet,” said Mr. Datta.

That is in part due to political will to keep the eurozone together. “Why is the European government holding on so hard” to the idea that Greece can repay its debt, asked Ewen Cameron Watt, London-based global chief investment strategist at the BlackRock Investment Institute. “The reason is the danger of precedent — if you give Greece a pass here, it is likely that other countries will want one, too.”

However, time is running out, and “there is a distinct possibility within the various amounts that need to be paid that we could go to capital controls in the short term, a bank run and a missed payment to the IMF,” Mr. Watt said.

That possibility is translating to the country's equities market. “Greece's expected volatility, over and above that of the global market, is about 43%,” said Melissa Brown, New York-based senior director, applied research, at Axioma Inc. The next-highest risk among major euro countries is Portugal, at 15.6%, followed by Belgium and France at 7% each. “So Greece clearly stands away from the pack, with volatility driven by political as well as financial concerns, including a possible exit from the euro,” she said.

Credit markets are pricing in the likelihood of a default, said Neil Williams, group chief economist at Hermes Investment Management, London. “Looking at the Greek bond curve out to three years, there is a far higher yield that has to be offered there than if you take it out over 25 years,” he said. If Greece does default, then the market has got it right. “It is a typical pre-default move in the bond curve,” he said.

The cost of insuring vs. a Greek default at the sovereign level in the credit default swap market has increased near fourfold since the middle of last year. “That suggests the markets are increasingly pricing in a Grexit,” said Mr. Williams.

Eric Lascelles, chief economist at RBC Global Asset Management Inc., Toronto, said: “Greece already defaulted earlier in this debt saga, and there is a good 40%, if not higher, chance of that happening again. In particular, the IMF now appears to be agitating for precisely this outcome, at least in the form of a net present value default with no change to the principal amount, but a lower coupon and longer maturity period.”

In terms of contagion risk for the rest of Europe, there would be a “knee-jerk negative reaction for bonds and the euro, but it will not last forever,” said Alan Wilde, London-based head of fixed income, global, at Baring Asset Management.

But money managers are more relaxed than they were in the past. “The risks of a default to the rest of the markets are reduced today vs. 2011-"12,” said J.P. Morgan's Ms. Toschi. “The key point is that the reduced risk of contagion is largely due to the fact that the burden of the Greek debt has moved from the private sector (mainly European banks) to the public sectors (in the shape of eurozone governments.)”

She said European governments hold about 60% of Greek bonds, the IMF holds 10%, and the ECB 6%. Greek banks hold a reduced amount of debt.

Another concern related to a Grexit is what the Greek government might do next. “What would happen were Greece to exit, and to become involved with Russia — that is a geopolitical event that we would have to keep an eye on,” said Mr. Griffiths. “It is a risk and could cause concern in the markets.”