Moody's Report: UK Schemes Move to Emerging Market Debt

(September 22, 2011) — A new report by Moody’s shows UK pensions are increasing their allocations to local emerging-market debt (EMD).

According to the firm, the trend among UK pension funds reflects a positive development for the stability of schemes’ long-term portfolios. “The positive elements are two-fold,” stated the report’s author Shin-Kobberstad, vice president and senior analyst at the firm. “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 report continued: “We believe that an increased allocation to EMD is a credit positive development for the stability of pension funds’ long-term portfolios. This diversification will (i) mitigate volatility that could stem from concentrated exposure to a limited number of issuers; and (ii) enhance portfolio returns generally, as overall growth prospects for emerging markets remain far stronger than for developed markets.”

Moody’s also outlined the risks of investment in EMD, noting that emerging-market bonds experienced significant volatility during the financial crisis and may continue to experience turbulence. “Investing in EMD is not without risks and pension funds would have to consider carefully the nuances of investing in EMD. Factors for consideration include careful credit selection, and, in the case of investment in local funds, evaluation of the investment manager and the credit quality of a fund, relative to its peers,” the report stated.

In contrast to the largely optimistic future of EMD investment among UK schemes voiced by Moody’s, a March study by Aberdeen Asset Management showed that schemes remain cautious over EMD.

Aberdeen, the global investment management group overseeing more than $287 billion of assets for institutions and private individuals, reported that limited knowledge about EMD was perceived as the most popular roadblock to investing. Nevertheless, the firm acknowledged the significant value of investing in the asset class. “Emerging Market Debt (EMD) has generally remained one of the best performing asset classes for over 10 years, despite high-profile crises,” the firm stated. “In our view EMD has the potential to enhance returns, providing diversification benefits for investors. We believe that most investors should at least allocate a modest holding to emerging debt, while investors more tolerant of risk should consider a more significant holding.”