SMITH_Clive_webRising levels of sovereign debt mean that investors should rule out a passive exposure to government debt and actively manage the risks that come with increasing issuance, says Russell Investments.

Sovereign debt is no longer uniformly safe after massive government issuance in recent years to combat the financial crisis, and warrants an active approach to the sector because the dispersion of risk among government bonds has broadened significantly, say Russell’s portfolio manager for Australasia, Clive Smith (pictured), and retiring director of consulting, Jim Franks, in a research paper, ‘Sovereign Risk – Meanings and Implications for Investors’.

The paper shows that the gross general government debt of the US is forecast to increase from 62 per cent to 108 per cent in 2014, and in the UK, from 44 per cent to 98 per cent within the same timeframe. For G-20 countries, this debt level is predicted to rise 40 per cent to 118 per cent in 2014.

The risks inherent in rising issuance means that government debt can no longer be viewed as “a risk-free anchor” in a balanced portfolio, and the weaknesses in Greece and Dubai show that managers need to have adequate resources to identify risks in sovereign debt.

Managers investing in offshore sovereign debt must have the flexibility to respond to rapid shifts in bond values and yields, because government debt should now be assessed with the same caution as traditionally riskier investments, such as corporate credit.

“Set-and-forget is a thing of the past, and conventional issuance-weighted benchmarks are becoming less relevant,” Smith said. “As public debt is continuing to grow in many countries, the problem is not going to go away anytime soon.”

But this increased risk should create opportunities for active fixed-interest investors, he said.

The paper identifies Australian government debt as a comparative ‘safe haven’ for sovereign debt investors. The domestic level of gross general government debt is projected to rise 18 per cent to 28 per cent by 2014.

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