The war in Ukraine has brought volatility to emerging market (EM) fixed income assets, but institutional investors remain optimistic for the months ahead, particularly in Asia, despite a wariness about the war’s economic impact, according to a survey published by Zürich-based Vontobel Asset Management.
More than half (64%) of institutional investors reported that they plan to increase, somewhat or substantially, their asset allocations to emerging markets fixed income over the next 24 months. Asia-Pacific (Apac) investors were also more likely to hold 5% or more of their fixed income in emerging markets (53%), compared with just 49% in the Americas and 36% in Europe.
“Asia-Pacific investors tend to have home bias in their portfolios, while European and US investors diversify across different asset classes. In emerging markets, they look at the entire spectrum and approach EM more broadly than Asia-Pacific investors,” said Benny Gay, head of intermediary clients in Asia at Vontobel.
MAINLAND CHINA HOLDS POTENTIAL
Despite decreased optimism around European emerging markets, other developing markets remain appealing for institutions. Apac emerging markets in particular drew interest, with 65% of global institutional investors expressing optimism about the region.
“In Asia, we see value in Chinese property and Macau gaming sectors following the recent sell-off, besides opportunities from Chinese local government financing vehicles and state-owned enterprises, which are beneficiaries of PBOC’s (People’s Bank of China) easing policies. The Chinese property market enjoyed a strong rally in mid-March after Liu He’s statements at the Financial Stability Development Committee meeting,” Gay said.
The top three reasons that global institutional investors cited for increasing their allocations to EM fixed income included diversification benefits compared with their current holdings (56%), the highly liquid nature of the market (48%) and favourable environmental, social and governance (ESG) prospects (47%).
Specifically for Apac investors, the opportunity for asset appreciation (44%) was another pressing consideration for them to increase allocation to the region, while the top two reasons were also diversification (58%) and the highly liquid market (44%).
DEFAULT RATES AND DEBT CONCERNS
However, institutional investors globally indicated that the EM fixed income market posed several challenges, with the top concern being default rates and debt load (51%). This was even more prevalent among Asia-Pacific investors (65%).
Other challenges for global investors included liquidity (48%), volatility (45%) and concerns about corporate governance, data quality and transparency as well as reporting standards (38%).
“Despite market headwinds, global and Asia-Pacific institutional investors recognise the need to diversify to provide both higher yields and insulation from market and geopolitical volatility in other asset classes,” said Simon Lue-Fong, head of the fixed income boutique at Vontobel.
The report also noted a drop in optimism for European emerging markets after Russia’s invasion of Ukraine. Before the war, 72% of institutional investors across the globe were optimistic about GDP growth, inflation and bond yield premiums in European emerging markets. The percentage fell to 55% after the invasion.
The survey covered more than 300 institutional investors and discretionary wealth managers globally in North America, Europe and Asia-Pacific during the first quarter of 2022.