Posted inEmerging MarketsNORDICSFixed Income

Finnish investors stuck in high yield and EMD

When visiting Helsinki earlier this month, our researcher found that local investors were increasing credit risk and lowering duration. Most interviewees considered increasing their strategic allocations to high-yield and emerging market debt necessary to generate sufficient income for clients.

Some interviewees have a preference for emerging market debt while others prefer high-yield bonds, but all are now overweight credit risk. One fund selector even said they had their internal guidelines changed to allow for a higher allocation to the two asset classes.

Eyes set on emerging market debt

Overall though, emerging market debt is more popular than high-yield bonds: one in four interviewees plan to reduce their allocation to the latter, as spreads have decreased considerably over the past year. But most investors just need the yields on offer, so they stick to their overweight asset class.

Emerging market debt is by far the most wanted asset class outside equities: roughly a third of Finland’s fund buyers plan to increase their allocation to both government and corporate bonds further over the next 12 months. The asset class is popular for the same reason as high-yield: on a historic basis, spreads do not look attractive, but emerging market bonds are still preferable to government bonds that have high duration risk.

It’s also important to note that emerging market debt is not anymore considered an exotic asset class: it has now become a standard ingredient of portfolios, just like developed market government and corporate bonds have been for decades. 

Finnish investors are basically feeling forced to take more credit risk, as they have simultaneously been lowering the duration of their bond holdings. The yields of less than 1% on 10-year eurozone government bonds do not anymore compensate for the associated duration risk, they believe. This only reinforces the case for credit: the spread buffers on high-yield and emerging market debt are thought to make high-yield and emerging market debt more resilient to rising interest rates, even though emerging market debt is historically vulnerable to Fed rate hikes.  

No alternative

 

There are of course alternatives available for fixed income investments, but they are not popular with the Finns. Only a minority invest in commodities as a separate asset class, and absolute return funds are traditionally met with scepticism in the Nordic country.

And, frankly, the Finns haven’t had much reason to change their mind on this, as the bulk of absolute return funds have disappointed investors in recent years. The Finns are confident a balanced fixed income portfolio is going to deliver better long-term returns than absolute return funds. As one interviewee put it bluntly: “Some of our institutional clients are interested in absolute return, but the returns just aren’t good enough to justify including these funds in portfolios.”

Part of the Bonhill Group.