By Danilo Masoni
MILAN (Reuters) - A few brave fund managers are swimming against the outgoing tide of investment in Italy, convinced that the expected failure of Prime Minister Matteo Renzi's constitutional referendum on Dec. 4 will offer buying opportunities as others flee.
Italian stocks have lost nearly a quarter of their value this year, and government bonds are also under attack, as the nation nears a referendum that, if the polls are correct, could prompt Renzi to quit, his government to crumble and the euro to take a hit.
Fund managers and market analysts expect the sell-off to intensify if Renzi's signature reform - reducing the Senate's powers to block legislation - sinks. But some funds are betting that the market's worst fears are unfounded.
"Investors' mood will change for one, two or three months, but it will not be a catastrophe if the 'No' wins," said Umberto Borghesi of UK-based Albemarle Asset Management which is launching an Italian equity fund four days before the vote.
"You cannot escape crises, but you can use them to your advantage".
Borghesi, who oversees around 400 million euros (341 million pounds) in assets, said Albemarle planned to raise up to 60 million euros for the new fund and would focus on under-valued stocks.
His top picks include some old-fashioned businesses such as book publisher Mondadori (MI:MOED), wood-working machinery firm Biesse (MI:BSS) and another maker of industrial parts, Saes Getters (MI:SAEI) - all stocks that he says are unloved, well-managed and have products that are in demand.
Paris-based AXA Investment Managers, one of Europe's biggest fund managers, says it is also holding its nerve. It has a 300 million euros Italian equity fund which is maintaining its overweight position on Italian banks, viewed as the most vulnerable to a sell-off.
"We must brace for volatility but we are not trading the referendum. That would be like buying a lottery ticket," said Gilles Guibout, AXA's head of European equity strategy, explaining that the banks' outlook was not all doom and gloom.
"We make investments looking at three years, not at three weeks."
Italy's banking industry, the euro zone's fourth largest, is groaning under 360 billion euros in problem loans and is at risk of a crisis unless several lenders can raise around 20 billion euros capital quickly, a tall order given listed banks (FTIT8300) have lost half of their value this year.
Guibout believes European authorities would not let a full-blown crisis happen, given the integrity of the euro zone itself could be at risk if Italian banks imploded.
"A break up of the euro zone or a bank meltdown are too big risks to let them happen," he said, adding that he was betting for the longer-term on banks being forced to merge and improve profitability.
Roberto Lottici, fund manager at Milan-based Banca Ifigest, said he was stepping up his exposure to the Italian market and focussing on stocks that offer secure income streams, such as utilities, or respond to different markets such as the oil price.
His picks include grid operators Snam (MI:SRG) and Terna (MI:TRN), oil firm Eni (MI:ENI), cable maker Prysmian (MI:PRY) and the saving shares of Italy's strongest big bank, Intesa Sanpaolo (MI:ISP).
In bond markets, analysts expect the spread between Italian government bonds and safer German bonds to widen 30 to 50 basis points. The gap, at about 180 points, is at its widest in two years but another 50 basis points would still leave it well short of the chasm that opened up in 2011 and 2012.
For now, though, many investors are standing near the exits as some European investment banks issue dark warnings.
The average short interest of Italian stocks listed on Europe's STOXX 600 index (STOXX) has grown by a third to 3 percent from January, according to IHS Markit data.
Among the most shorted Italian firms, the amount of stock out on loan has fallen for banks UBI (MI:UBI) and UniCredit (MI:CRDI) while it has risen for oil services firm Saipem (MI:SPMI) and eyewear maker Luxottica (MI:LUX). Short interest in the broader STOXX index has risen by a smaller 20 percent to 2.6 percent.
Deutsche Bank (DE:DBKGn) has said a No vote could lead to a worst-case scenario where Italy holds a euro membership referendum that could wipe out half of the country's stock market value by early 2018.
As insurance, Albemarle's Borghesi said his new fund would use Milan index futures to target the relative performance of his stocks. If the wider market slumps but his stocks fall less than the index, his fund would still make money.
"It's hard to say if markets will go up or down. But if I pick companies with good management and products there is a good chance they'll do better than the market," he said.