GLOBAL - Emerging market equities are likely to attract increasing interest from European pension funds in 2012 at a time when the sovereign debt crisis in Europe is still looming, but investors will need to diversify their investments within the emerging markets space, according to Aviva Investors.

Laurence Bensafi, head of emerging market equities, said some emerging markets such as Taiwan paid high dividends, but that there was still an important disparity in terms of interest rates from one market to another.

"The equity investment depends on the cost that will be incurred to pension funds," she said.

"A company can provide a return on equity of 10%, which remains highly attractive only if the cost of equity is as low as 2%.

"However, some countries still impose high interest rates, with the cost on equities going up to 15% in some cases."

As a result, Bensafi said pension funds would do well to invest in equities as well as bonds.

"In the past, investing in emerging markets was only a question of taking exposure for pension funds," she said.

"But, this asset class has matured significantly over the last five years, and the set choice is now broader.

"Investing in emerging market bonds will help investors to lower the level of volatility within their portfolio."

Earlier this year, IPE reported that adding bonds to an emerging market portfolio clearly improved the Sharpe ratio.

Since 1994, EM equities returned 5.3% annualised with volatility of almost 25%, while a 50/50 portfolio rebalanced biannually returned 9% with volatility of 17%.

Bensafi said that the opportunity set in emerging markets would expend rapidly both on the fixed income and equity sides.

She also said she saw good potential in India, where the regulatory regime was "still unstable but likely to change over the next few years", providing a high-risk premium for investors.