Money managers are carefully watching the political situation in Italy unfold, deeming the country "too big to fail."
But sources said they're not just watching for negative investment effects from the country's political and fiscal problems: They're also looking for opportunities to add to positions.
"Political risk is back with a vengeance in Italy," said Emiel van den Heiligenberg, head of asset allocation at Legal & General Investment Management in London. "As the third-largest global issuer of government bonds after the USA and Japan, Italy is too big to be allowed to fail without severe contagion to the global financial system. However, it is also too big to comfortably bail out using tried and tested mechanisms."
Recent weeks have seen Italy's population and investors forced to reckon with a populist government coalition and a potential snap election.
As the news unfolded, Italian bond yields moved higher, by more than 100 basis points in May and the Italian equity market was down about 11% since the start of May.
The current situation in Italy carries "similarities to the eurozone financial crisis" of 2011 and 2012, said Andrew Harman, London portfolio manager of First State Investments' diversified growth fund.
But that time the focus was on Greece. "Italy is the eurozone's third-largest economy and has a significant impact on the European Union and euro," Mr. Harman said.
The country's "new populist government brings with it a high degree of uncertainty, including introducing the potential of a referendum on euro membership. This crisis has the potential to be a short-lived political crisis, or a longer saga of currency redenomination (of the Italian lira), which would have much wider implications for global assets and economic prospects that far exceed Italy's borders," Mr. Harman said.
The diversified growth fund did not hold Italian debt up to June 4, with executives viewing the yields and spread to German bonds "too low to compensate for the investment risks." However, "with the significant increase in Italian yields, we added a long Italian/German spread position to the portfolio on ... (June 4). This will benefit if the spread between bonds in Italy and Germany narrows," he added.