Pension funds are increasingly investing passively in emerging market debt (EMD). In order to be able to integrate ESG criteria consistently, a customised index is often necessary. But only larger schemes tend to have access to such solutions.

EMD had long been considered the last frontier for passive investors, as the asset class was seen as insufficiently liquid and therefore hard to replicate. But things have changed over the past decade with the likes of State Street Global Advisors (SSGA) and BlackRock rapidly expanding their market share.

Passive advance

“Growth by passive providers has been facilitated by the failure of active managers to generate stable outperformance,” according to Sabine van Solingen, head of institutional clients Benelux at SSGA.

In the Netherlands alone, SSGA saw its passively managed pension assets in EMD grow from $4.4bn to $33bn over the past decade. Among others, SSGA runs a €7bn mandate for health care scheme PFZW since 2016.

The rise of passive investing in EMD has, at least for the past few years, been coinciding with a different trend: that of ESG investing. Almost all pension funds have been integrating ESG criteria in their investment policies one way or another, at least for (part of) their equity portfolio.

Back in 2019, metals industry scheme PMT was the first Dutch scheme to introduce a customised ESG benchmark for its EMD portfolio, excluding the 27 countries scoring worst on several ESG metrics. Pensioenfonds PostNL and PME have introduced similar benchmarks since.


Pensioenfonds Detailhandel, the retail industry scheme, was the most recent pension fund to introduce a customised EMD benchmark, based on the UN’s Sustainable Development Goals (see box). And it certainly won’t be the last. The outbreak of the war in Ukraine last year served as a wake-up call for many a pension fund as investments in the country were rendered worthless overnight because of Western sanctions.

SSGA’s client PFZW was among the largest victims as it was heavily invested in Russian government bonds. The Ukraine war triggered a process at the healthcare scheme to investigate how to integrate ESG criteria in its EMD portfolios, but a revised policy is yet to be formulated.

Detailhandel excludes non-democratic countries

Pensioenfonds Detailhandel, the Dutch scheme for the retail industry, introduced customised benchmarks for its hard and local currency portfolios in late 2022.

The benchmarks have higher exposures to countries and companies that score well on the UN’s Sustainable Development Goals, and the 20% worst scorers have been excluded.

The fund introduced a similar method for its European corporate bond portfolio back in 2021.

In addition, the fund’s index provider FTSE Russell performed a screening to filter out non-democratic countries from the fund’s investment universe.

“Countries that have been classified as non-free by Freedom House have not been included in the new index,” a spokesperson for the fund told IPE.


Funds such as PFZW and Detailhandel are large enough to have bespoke mandates even in smaller asset classes such as EMD. But most pension funds lack in size to be eligible for a separate EMD mandate and therefore tend to invest in funds.

While the number of actively managed funds with ESG integration has risen steadily, there are still very few passively managed EMD funds with an ESG filter.

SSGA, which is the largest passive EMD investor together with BlackRock’s iShares, offers just one EMD index fund with sustainable characteristics. The asset manager declined to say whether or not it is planning to increase its product offer in this space.

SPMS sticks to active

Not only pension funds without access to a mandate prefer to invest actively in EMD. The €11bn scheme for Dutch medical specialists SPMS performed a search for a new manager for its EM hard currency bond portfolio.

SPMS was unhappy with its manager Ashmore as returns had lagged for an extended period. The pension fund also looked for a passive alternative, but ended up awarding an active contract to PIMCO, said investment manager Ravien Sewtahal.

“We had a number of demands that were not so easy to implement with a passive solution. For example, we wanted the manager to allocate at least 10% of the portfolio to green bonds,” he said, adding: “You also often see that you end up investing relatively more in countries with high credit ratings if you choose a passive fund, because of the correlation between ESG ratings and credit ratings. We don’t like that as we want to invest more in countries with the highest potential for improvement. That’s difficult with a passive approach. Besides, the hard currency universe offers relatively more opportunities for active managers to generate outperformance.”

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