(April 15, 2011) — At a recent investor forum sponsored by Mercer, keynote speaker and Harvard professor of economics Gita Gopinath told a group of institutional investors and asset managers that in order to deal with the European sovereign debt crisis, holders of peripheral European sovereign bonds will need to take a loss on their investments, which they have not yet done.

Bondholders in attendance tended to agree. At the Dublin-based forum — titled Adjusting to New Realities — among Europe’s largest institutional investors and asset managers responsible for the investment of more than €1 trillion of funds, 75% of those in attendance saw a high likelihood of default in the Eurozone within three years. Gopinath asserted that the solution would likely be for bondholders, namely pension funds, to take some form of a loss on their investments, “given the sheer scale of the debt amounts involved.”

“In particular, the crisis has shown the weakness of traditional bond benchmarks based on market-capitalisations,” Mercer’s European Chief Investment Officer Hooman Kaveh said in a report describing the forum. “However, new approaches to bond benchmarks, whilst having many merits, also have flaws, and it is important for investors to be aware of these.”

The comments from Mercer come as the cost of insuring Greek debt has hit its peak amid fears that the country will default on its borrowings, with the yield on Greek bonds climbing today following remarks by the German finance minister, Wolfgang Schäuble, that “further measures” may be needed to bring Greece’s finances under control. The International Monetary Fund and the European Union are expected to review Greece’s finances in a June report, which could potentially force the country to restructure its debt, imposing losses on bondholders.

Furthermore, Gopinath told delegates that as the global economies of strong emerging markets, such as China and India, face a variety of imbalances as they deal with high inflation and fiscal deficits. Meanwhile, among developed economies, public debt is at levels last seen after World War II. Additionally, the forum discussed Mercer’s view that clients should continue to build exposure to emerging markets in their portfolios. The encouragement to continue to seek emerging market exposure is echoed by US financial services firm State Street, which foresees heightened interest in emerging markets, urging investors to seize opportunity in smaller economies. According to research carried out by SSgA’s Active Emerging Markets investment team since January 1997, BRIC countries (Brazil, Russia, India and China) have underperformed a group of smaller countries within the emerging world. As of March 2011, according to the firm, non-BRIC emerging market countries outperformed BRICs by 39%.

“Investors, while maintaining a core exposure to BRIC countries, should not close their eyes to other growth areas in the emerging world,” Chris Laine, portfolio manager for active emerging market equities at SSgA, said in the report. “Many of the smaller emerging and frontier economies have quietly been making investor-friendly reforms and deserve the attention of international investors,” he said, referring to the smaller markets of Columbia, Turkey, Chile, the Czech Republic, Egypt, Hungary, Israel, Peru, Poland, Thailand and the Philippines.