UK - UK pension funds are increasing their allocations to local emerging-market debt (EMD), according to a new report by Moody's.
The move is described as a positive development for the stability of pension funds' long-term portfolios by Moody's Investors Service.
The report's author, Shin-Kobberstad, vice president-senior analyst said: "The positive elements are two-fold. First, it is likely to mitigate volatility that could stem from concentrated exposure to a limited number of issuers. Second, it will enhance portfolio returns generally, as overall growth prospects for emerging markets remain far stronger than for developed markets."
The survey shows that the holdings of EMD in UK pension funds were less than 1% of their overall assets under management. Moody's describes this as an "inadequate portfolio diversification given that the emerging economies account for approximately 30% of world GDP."
Returns on emerging market debt are expected to surpass UK inflation partly driven by strengthening currencies in emerging markets. The report finds the positive interest rate differential between a local-currency bond and a UK gilt of similar duration could be over 8% in some local emerging bond markets.
Meanwhile, changes in structure of capital markets have led to more transparency, due to increased liquidity and diversification, Moody's said.
However, officials at Moody's note that investing in EMD is not without risks.
"Emerging-market bonds experienced significant volatility during the financial crisis, with the average spread on single-A EMD rising by nearly 600 basis points at the peak. The significant rise in yields would have resulted in realised or unrealised losses that worsened a pension fund's funding status," said Shin-Kobberstad.
Moody's findings reflect details released by Mercer on manager search activity which showed a growing interest in emerging markets debt. Worldwide, emerging market debt searches increased from four in 2009 to 45 in 2010. (Global Pensions; 16 May 2011)
US funds have also shown interest. The New Mexico Educational Retirement Board hired two new emerging-market asset managers to run $195m, giving $120m to Pictet and $75m to Citigroup affiliate EMSO Partners. The mandates helped the pension fund reach its 2% allocation to emerging market debt. (Global Pensions, 17 August 2011)
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