Bond market is the key
Being small and in the middle of the Atlantic make Iceland easy for asset managers to overlook. Its prosperity, fully funded pension system and outperforming equity market mean that it is probably a mistake to do so.
“Given the number of people living there it’s an interesting market,” says Peter Preisler of T Rowe Price. “The most obvious thing in the Icelandic market is that the interest rate has come down substantially and that is causing the Icelandic pension funds to seek diversification. So while they have been in a situation where they could just lean back and hold their domestic investments, we see a rapid change of interest towards international investments in both equity and fixed income. And that is something that will continue.”
The fall in interest rates followed a change during the summer in regulations affecting the government Housing Financing Fund, whose issuance to provide mortgage finance is the backbone for the local bond market. “They changed the structure of how they issue the bonds, essentially the settlement issue, and they switched maturities from being 25 and 40 years to 20, 30 and 40 years and more recently issued a 10-year bond,” says Pétur Adalsteinsson with small local independent asset manager VBS Securities. “And they are now issued through Euroclear. The changes made the bonds more attractive to foreign investors.”
Bjørn Gudbrandsson of Iceland Securities says: “The size of the Icelandic security market offers both advantages and disadvantages. For example, most of the players are Icelandic, at least on the stock market. We have almost no short sellers, we know every player and there is low correlation with other global equity markets. That gives us better chance to be in stocks even though the world stockmarkets are down. But the increased prominence of foreign players in the bond market makes it more difficult to gauge the market, it is more difficult to read.”
Adalsteinsson adds: “At the same time all the large local banks started to compete with the Housing Financing Fund and are now offering mortgage loans on even better terms. This has pushed the interest rate even further down, to a real interest rate of 3.6-3.8% from 5.0% in the early summer. So that’s a lot of changes.”
Pension funds, which also offer mortgage loans and which in some funds make up to 20% of the portfolio, have reacted to the changes by lowering their interest rates to prevent their borrowers remortgaging with banks. “They still have a premium of about 50bps over the Housing Financing Fund’s paper so it remains a fine investing opportunity,” says Kristjana Sigurdardóttir, fund manager of the Almenni Pension Fund, an open pension operated at Islandbanki, one of the two major local players.
“Aware that interest rates cannot come down much further, some of the leading investors are deciding to add more international asset classes to their portfolios,” says Preisler. “That is something that is definitely of interest to us and to all money managers.”
Sigurdur Kristinn Etilsson, executive director institutional asset management of Kaupthing AM, Iceland’s major player, says: “Risk reporting is becoming increasingly vital for pension funds because falling interest rates make it more difficult to match liabilities. So interest in alternatives is increasing and we are trying to find the right markets for them. We already have some products that can suit them, private equity for example, and we have teamed up with some US and European players in alternative investments. But hedge funds are difficult for them to opt for.”
Sigurdardóttir agrees: “With hedge funds you really have to be well informed because it’s a little like a black box. Foreign institutions are offering private equity funds and hedge funds, and a few pension funds have been looking into alternatives, some of them investing on a small scale. We have a relationship with Vanguard and, for our bigger clients, Wellington Management, offering more traditional global, US and European mutual funds. We have been discussing the possibility of offering alternatives, and if we were to team up with external providers they would have to be companies in which we have confidence and trust.”
For T Rowe Price’s Preisler this sort of relationship offers a useful model. “Instead of us trying to beat our way into the market, we may work our way in by going directly to the larger players both offering our products and teaming up with distributors.”