Investors look to ECB for support after bond shakeout

* Pension funds see government paper as a long-term investment

* Some hedge funds nursing losses after Bund rout

By Sinead Cruise

LONDON, May 8 (Reuters) - Following a recent sell-off in German bunds, pension fund managers are resisting making any major changes to their exposure to European government debt, confident that demand from the European Central Bank (ECB) will stabilise markets.

Around a third of all outstanding euro zone sovereign paper offered negative yields last month, prompting some investors to quit trades that have effectively forced them to pay governments for the privilege of lending to them long-term.

The sell-off in German sovereign debt - traditionally a safe haven - was particularly sharp.

But portfolio managers expect continued European Central Bank (ECB) purchases of sovereign paper - the cornerstone of Governor Mario Draghi's plan to revive to stimulate the euro zone economy - to stabilise things.

The recent sell-off, said Chris Iggo at AXA Investment Managers, "was a collective realisation that negative bond yields just don't make any sense and that, save for some economic catastrophe, interest rates will rise over the medium term."

"It is likely that we have seen the lows," said Iggo, who is the chief investment officer for bonds.

Government bonds are a key part of pension fund portfolios because they are viewed as an I.O.U that will be paid on time and in full. For this reason, most pension funds prefer to hold on to their sovereign paper for the long haul.

Bonds account for nearly a third of the $33 trillion of assets owned in the world's major pension markets, according to a recent study by consultancy Towers Watson. In Britain, more than a quarter of pension funds were made up of government bonds in 2014.

HEDGE FUNDS HURT

Hedge funds or other actively managed funds which make money by trading in and out of bonds priced on secondary markets have had to move swiftly to deal with the recent bond market rout.

CTAs, hedge funds that use mathematical models to bet on long running market trends, suffered in April because they had bet on further rises in bond markets. Data from industry tracker Eurekahedge showed CTAs lost on average 1.7 percent in April.[ID: nL4N0XX3IE]

"As the trend reversal occurred, they struggled," said Philippe Ferreira, head of research at Lyxor Asset Management.

Some of the biggest hedge fund losers in April were Cantab Capital Partners Quantitative Fund, down 9 percent and ISAM Systematic Fund, down 6 percent, according to data seen by Reuters.

Cantab declined to comment. ISAM did not respond to requests for comment.

STABILISING

However by Friday benchmark 10-year German sovereign debt had snapped a 9 day losing streak with its yield falling 7 basis points after rising nearly 0.80 percent on Thursday. Bond prices rise when their yields fall.

Many investors think German debt is still priced too high but they say the ECB's 1 trillion-euro quantitative easing programme, which is heavily reliant on purchases of German government debt, will keep prices up until Sept. 2016 at least.

"I wouldn't bet a single euro on the ECB tapering its programme," said Franck Dixmier, Chief Investment Officer of Allianz Global Investors' 171 billion euro European fixed income business.

"Draghi was quite clear in his last press conference that what really matters is looking beyond headline numbers and assessing genuine medium to long term economic developments. The ECB is far from achieving its ultimate objectives of real price stability and inflation of around 2 percent."

As a result, few money managers are making long-term material changes to their portfolios or strategies which assume that European government debt prices are still in the last stages of a 20-year bull run.

A surge in the amount of cash seen flowing into the market in July is also expected to support pricing, investors say.

"We will see a huge negative net supply in July -- around 120 billion euros -- and that will bring relief to prices of euro zone government debt," Dixmier said.

(Additional reporting by Nishant Kumar; Writing by Carmel Crimmins; Editing by Sophie Walker)