Heightened demand for Danish sovereign bonds, driven by the country’s perceived status as an economically and politically stable safe haven, has put its central bank in a difficult situation. While the inflows offer the Danish government access to funding on terms that southern European nations can only dream of (see News Round-up), the shift has also put the Danish krone under severe strain. Some investors are betting that the currency’s peg to the euro will be cracked, and the central bank reportedly spent more defending the krone in May than at any other time since the start of 2010.
Appetite for Danish government debt also poses a dilemma for pension funds. Sovereign bonds remain a core allocation for such investors, but low yields have forced many to look elsewhere for income-generating assets. Data from the Federation of Danish Investment Associations (IFR) shows that locally- managed funds investing in domestic bonds suffered outflows of dkk 6.4bn (€860m) in the first five months of 2012 (see graph 1). Our research indicates that the trend will continue.
• Denmark sold two-year government bonds at a negative interest rate for the first time, issuing dkk 1.55bn at a rate of minus 0.08% on 19 June. Danish central bank head Nils Bernstein said the move was designed to weaken the Danish krone.
• The use of private pensions alongside the state scheme increased markedly between 2000 and 2010, particularly in smaller rural communities. Analysis from state pension provider ATP shows around half of all pensioners in Denmark have a private scheme.
• The Danish Foreign Office said the country could generate revenues of dkk 10bn from water technology, if it had China as a customer. Trade minister Pia Olsen Dyhr said water technology is Denmark’s most innovative product, adding that “water is the new gold”.
• A Danish computer programme called sinAI trades stocks worth more than dkk 1bn in a new Luxembourg-domiciled fund from investment organisation Maj Invest. It was launched by Maj Invest portfolio manager Kurt Kara.
According to our study, which was conducted in June and included face-to- face interviews with fund selectors at several leading Danish pension schemes, more than half of Danish investors expect to reduce their EU government bond weightings during the next 12 months. Institutions are instead turning to alternative areas of fixed income. About 70% plan to increase their use of high yield corporate bond funds during the next year, for example (see graph 2 on page 2). Many of our interviewees prefer short-dated high yield securities in particular, owing to their favourable risk/return profile.
Appetite for short-duration high yield is perhaps unsurprising, given strong demand for the broader asset class this year (Lipper estimates high yield funds attracted European inflows of €19.3bn in the first four months of 2012), plus investors’ continued focus on assets with low short-term price volatility. But in Denmark, even pension funds are focusing on the short-dated end of the high yield spectrum, despite the long-term nature of their liabilities.
Other attractive high-yielding options, say fund selectors, include direct investments in Danish mortgage bonds and emerging market debt strategies – which enable them to tap into developing world growth while generating income. IFR data shows inflows into emerging market bond funds hit dkk 4.5bn between January and May, up from dkk 2.9bn in the equivalent period last year.
Emerging market debt
Further strong demand in this area is likely, according to our research. Some 71% of Danish interviewees expect to boost their exposure to emerging market sovereign bonds over the next 12 months – a notable increase on the 26% of delegates who attended the Expert Investor Denmark conference last October (see graph 3). Many fund selectors perceive emerging market debt as less risky than bonds issued by governments in southern Europe. In particular, they favour local-currency debt strategies, which additionally allow them to benefit from currency appreciation in the developing world.
Appetite persists for emerging market assets more broadly, with 28% of interviewees planning to “significantly” increase their exposure, and a further 44% expecting to boost their allocations to a lesser degree (see graph 4). Demand even extends to stock market investments, despite the generally difficult environment for equity funds. Net inflows into Danish-domiciled equity funds from January to May were just 1% of the total recorded for the first five months of 2011, according to IFR figures. Yet emerging market funds have pulled in dkk 4.2bn this year – more than any other equity sector.
Our research shows Danish appetite for emerging market equities will grow further, with some 43% of interviewees expecting to boost their exposure to the asset class, and just 28% planning to reduce their allocations. But the most common equity shift during the next year is likely to be towards the US (the second-best selling equity sector in Denmark in 2012, with inflows of dkk 4.1bn).
Unperturbed by uncertainty
More than half of the investors we spoke to plan to increase their allocations to US stocks. Interviewees are unperturbed by uncertainty surrounding the presidential election in November and upbeat on the strength of the US economy, as well as the balance sheets of the country’s larger corporations.
Concerns over the eurozone continue, however. Just 14% of attendees at last year’s Denmark conference planned to reduce their exposure to EU equities over the next 12 months, but that proportion has risen to 85% (see graph 5).
Investors are particularly concerned about the future of the Spanish and Greek economies, and no longer consider pan- European equity funds to be a core holding. Instead, they favour strategies investing specifically in Nordic stock markets, owing to the region’s stability. Similarly, many interviewees are upbeat on Danish commercial property investments, as a play on the country’s relative economic strength.
This combination of positivity on emerging markets, the US and northern Europe, and negativity on the eurozone, has left many fund selectors uncertain on the outlook for the global economy as a whole. Some 85% of interviewees have a neutral macroeconomic view as a result – although it should be noted this is a more positive level of sentiment than October last year, when half of the Expert Investor Denmark delegates were downbeat on the global economy (see graph 6).
Lack of confidence on the likely direction of markets is encouraging investors to focus on asset class diversification, and all of our interviewees expect to maintain their exposure to multi-asset solutions over the next 12 months.