Institutional investors see value in emerging markets fixed income

Despite market volatility, investors around the world remain optimistic for the months ahead, study shows

Institutional investors see value in emerging markets fixed income

The ongoing conflict in Ukraine has increased volatility in emerging market fixed income assets. Institutional investors in the United States and around the world are concerned about the war's market and economic effects but remain optimistic for the months ahead, according to a research published by Vontobel Asset Management.

During the first quarter of 2022, Vontobel polled over 300 institutional investors and discretionary wealth managers across North America, Europe, and Asia Pacific.

Prior to Russia's invasion of Ukraine, 72% of institutional investors throughout the world were bullish about GDP growth, inflation, and bond yield premiums in European emerging economies, according to the study. However, only 55% of institutional investors were bullish in their responses after the invasion.

Institutions find emerging markets in general intriguing despite waning optimism in European developing markets. Over the next 24 months, more than half (60%) of US institutional investors aim to expand (somewhat or substantially) their asset allocations to EM fixed income.

Favorable ESG prospects (64%), asset availability (64%), and diversification benefit against present holdings (50%) were the top three reasons given by US institutional investors for raising their investments.

Simon Lue-Fong, Head of the Fixed Income Boutique at Vontobel stated, “Despite market headwinds, institutional investors recognize the need to diversify to provide both higher yields and insulation from market volatility in other asset classes. Emerging markets fixed income can meet those needs in investor portfolios but requires an experienced active manager to navigate the unique challenges associated.”

The top hurdles that US institutional investors face when investing in EM fixed income include liquidity (52%), low expectations of risk-adjusted returns (52%), anxiety about default rates and debt load (41%), and concern about their institution's lack of expertise in the sector (41%).

“These concerns are not new; the asset class is still treated as an exotic niche by many investors. However, for active investors that understand the asset class, it offers enormous opportunities—the impact of default rates is often exaggerated and volatile periods offer excellent opportunities to exploit market inefficiency,” Lue-Fong said.

With the amplified importance of ESG factors in emerging markets, almost all (93%) US institutional investors say they use ESG investment strategies in their EM fixed income allocation, including systematic screening to include or exclude securities (53%), impact investing (51%), and engaging with issuer management to influence ESG policies and practices (42%).

US institutional investors report several barriers to making ESG-focused investments in EM fixed income despite widespread acceptance: skepticism about ESG investments' positive impact (59%), data inconsistency by third-party providers (57%), and a perception of higher risk linked to emerging markets fixed income (52%).

“Within the last few years, ESG has moved to the center stage for many US institutional investors, and emerging markets fixed income investors are in a unique position to generate returns while making an impact,” said Amit Mukadam, Head of North America Institutional Client Group at Vontobel.