Fixed income investors have become increasingly interested in emerging market debt and ESG exposures, highlighting an opportunity for ETF issuers to develop products along these lines.
Nick Tolchard, Head of EMEA, Invesco Fixed Income.
Nearly three-quarters (72%) of investors now have an allocation to emerging market debt compared to 49% one year ago, while over half (54%) believe ESG analysis can unlock hidden value within fixed income.
These were the findings of the third annual Global Fixed Income Study conducted by US and European ETF issuer Invesco.
To conduct the study, Invesco interviewed 159 fixed income asset owners across North America, EMEA, and Asia-Pacific (APAC) with a combined $20 trillion in assets under management.
Respondents included defined benefit and defined contribution pension plans, sovereign wealth funds, insurers, private banks, diversified fund managers, multi-managers, and model builders.
Emerging market debt
According to Invesco, growing interest in emerging market debt reflects the sector’s relatively attractive yields and diversification potential within a broader multi-asset portfolio.
The trend has been driven by EMEA and APAC investors where 80% and 89% of respondents, respectively, have allocations to emerging market debt, compared to just 51% in North America.
Specialization is also on the rise with 63% of emerging market debt investors seeking the return potential of country-specific allocations. China is of particular interest to 42% of emerging market debt investors who are encouraged by the country’s lowering of barriers to investment.
Invesco notes that the rise of emerging market debt allocations as a source of return enhancement reflects the low yields currently offered within core fixed income exposures. EMEA investors, in particular, have piled into emerging market debt to boost returns with over two-thirds (69%) of those invested having done so for this reason. This is in contrast to just a quarter (25%) of North American investors, who tend to see emerging market debt as a diversifier.
Nick Tolchard, Head of EMEA, Invesco Fixed Income, commented, “Investors are no longer thinking of emerging market debt as a monolithic asset class. We’re now seeing increased interest in specific markets which we see as a long-term trend. It’s notable that Chinese fixed income is one of the best performing asset classes this year, beaten only by US Treasuries.”
ESG fixed income
The study also found that fixed income investors have sharply increased their ESG integration with EMEA and APAC investors being the most enthusiastic for ESG exposures: 80% of EMEA and 69% of APAC investors now incorporate ESG into their fixed income portfolios, up from 51% and 38% in 2019 respectively. Just over half (56%) of North American investors currently utilize ESG bond investments.
Gone are the days when investors viewed the adoption of ESG investing principles as a hindrance to investment performance with only 3% of survey respondents still maintaining this belief. In contrast, half (50%) of investors that have incorporated ESG within their fixed income portfolios believe the strategy can help return enhancement.
EMEA investors had the most positive attitude towards ESG of all regions surveyed. Over half (52%) stated incorporating ESG into their fixed income portfolios helped boost returns, while a third (34%) anticipate ESG considerations having a ‘much greater influence’ in three years’ time.
Tolchard said, “Many investors used to assume that integrating ESG would compromise performance, but attitudes have changed. Across all regions, very few investors report that it has hindered returns, and in the case of EMEA, a majority have said that integrating ESG has improved them.”
Bond market liquidity
A majority of respondents expressed concern around bond market liquidity. In particular, these investors were uncertain how bond markets would behave during challenging periods following the introduction of regulations such as Dodd-Frank and the retrenchment of traditional market makers after the global financial crisis. In response, 59% of fixed income investors have turned to ETFs to help improve liquidity and reduce market risk.
Fixed income investors were also becoming increasingly risk-averse prior to the Covid-19 market turmoil with almost half (43%) believing the end of the record-long economic cycle was a year or less away. Despite some late-cycle risk-taking, the confluence of end-of-cycle concerns and fears of trade wars may have translated into portfolios that were better protected from the current, unprecedented exogenous shock impacting markets today.
“The perception that spreads were tightening drove many investors into cautious positions,” said Tolchard. “Given what Covid-19 has done to the market, those investors may be relieved.”