Nordic appetite grows for emerging market debt

Allocation to emerging market debt among Nordic investors could increase sharply, according to a recent study published by Aberdeen Asset Management. Jonathan Boyd takes a look

Global mandates, including exposure to emerging market equities, have long been popular in the Nordic region.

However, the balance of asset allocation is set to change, according to the results of market research done jointly by Aberdeen Asset Management and Kirstein A/S.

It found that the average portfolio in the region has just 4% exposure to emerging market debt (EMD).

This could rise sharply as more than 40% of Nordic investors expect to increase their exposure this way in future, especially in Sweden and Norway where existing exposure is the lowest of the four key regional markets.

Three in four Swedish investors are considering increasing their EMD exposure, the research suggests.

There are a number of reasons for the change. Increasing awareness of risk management is one. ­

Diversification is a way to manage risk, and there is growing awareness of fundamentals such as economic growth rates and financial balances being in better shape in emerging markets than developed ones.

Political instability and inflation are cited as risks ­associated with investing in emerging markets.

But as events in Greece have proved, developed markets are not immune in this respect.

Instead, currency risk is seen by many as the biggest challenge in considering a bigger exposure to EMD.

Then there are liquidity fears. In addition, regulation in the form of Solvency II rules has thrown up another unknown according to respondents’ comments ­discovered during the qualitative research.

Solvency II potentially could restrict investments in EMD assets because of the stricter capital requirements that this regulation could lead to.

GREAT TIME FOR CHANGE

Still, the scope for change remains significant. The research was based on both quantitative and ­qualitative research involving 40 institutional investors in the Nordic region.

The median assets under management was €3-€10bn, although nine investors had more than €20bn in AUM.

One in five of these investors have very little or no ­allocation to EMD. Just four small Danish investors and two Finnish pension funds had more than 8% of their total portfolios invested in EMD.

Size played a role in the relative allocation, the research found. Bigger investors as defined by AUM had lower levels of EMD exposure. Three out of four of the biggest investors had no exposure.

Investor location affected the results. By market, Danish investors had 4.9% allocated to EMD, while Finnish investors had 5.1% exposure.

Sweden and Norway had much lower levels of such allocation. The research suggests that Sweden’s key AP pension funds are incentivised to invest only in investment grade debt.

Both Norwegian and Swedish investors typically prefer global to segmented portfolios.

Some investors with low or no exposure simply stated that they could not find suitable risk-adjusted returns from the EMD asset class.

Key factors affecting future EMD allocation include: improving EM fundamentals, improving regulatory frameworks, the inflation outlook, and EMD asset liquidity.

Investors are still concerned about inflation being too high in emerging markets.
Some are willing to buy into local currency debt, whereas others will consider only hard currency issues, the research suggests.

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