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Institutional investors see opportunities in emerging markets fixed income despite turbulent markets

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The war in Ukraine has added continued volatility to emerging markets fixed income assets. According to a study published by Vontobel Asset Management, whilst institutional investors globally are wary of the war’s market and economic impacts, they remain optimistic for the months ahead.

Vontobel surveyed more than 300 institutional investors and discretionary wealth managers globally in North America, Europe and Asia-Pacific during the first quarter of 2022. According to the survey, 72% of institutional investors across the globe were optimistic about GDP growth, inflation and bond yield premiums in European emerging markets prior to Russia’s invasion of Ukraine. However, among responses received after the invasion, only 55% of institutional investors were optimistic.

Despite decreased optimism around European emerging markets, the broader emerging markets space is seen as appealing for institutions. More than half (64%) of institutional investors report that they plan to increase (somewhat or substantially) their asset allocations to emerging markets fixed income over the next 24 months. This was particularly pronounced among UK institutions, with 72% of UK investors planning to increase emerging market fixed income allocations over the next 24 months. Of these, 24% of UK investors said they would make a substantial increase of more than 10%.

This confidence in emerging market fixed income is also already reflected in the existing portfolios of UK institutions. Nearly twice (14%) as many UK institutional investors currently hold between 10 – 20% of their portfolio in EM fixed income compared with the global average of 8%.

The top three reasons that institutional investors globally cite for increasing their allocations included: diversification benefit versus current holdings (56%), highly liquid market (48%) and favourable ESG prospects (47%).

When investing in emerging markets fixed income, institutional investors globally indicated the top challenges their institutions face as: concern about default rates and debt load (51%), liquidity (48%), volatility (45%) and concern about corporate governance, data quality and transparency, and reporting standards (38%).

Given the heightened importance of monitoring ESG factors in emerging markets, almost all (91%) of institutional investors across the globe report using ESG investment strategies in their emerging markets fixed income allocation, including: impact investing (55%), systematic screening to include or exclude securities (54%) and engaging with issuer management to influence ESG policies and practices (49%).

Despite the widespread adoption, institutional investors report several barriers that hold their institutions back from making ESG-focused investments in emerging markets fixed income: data inconsistency by third-party providers (62%), skepticism about the positive impact of ESG investments (61%), the perceived higher risk associated with emerging markets fixed income (43%) and the lack of suitable ESG offerings from external asset managers (43%).

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