Now is an opportunity to invest in yields 50-150 basis points higher than European bonds, thanks to the current environment of rising short-term interest rates and high spreads.
This extra yield has solid support too: many of these are crossover companies (on the borderline between IG and HY) as well as companies that are high quality but unrated, which easily get funding in a large market, highly diversified across sectors and currencies.
There’s been a sizeable increase in the allure of Nordic bonds in the current environment of market and economic uncertainty.
"In the current environment of short-term interest rates having already risen sharply and with little room to further do so, and with spreads already high, this could be an intriguing investment opportunity" according to Juhamatti Pukka, Head of Fixed Income at Evli.
With Nordic bonds, investors can gain an additional 50-150 basis points of yield versus comparable euro-denominated European bonds, according to Juhamatti Pukka, and their spread versus European investment-grade quality bonds is currently high, even more so than before the pandemic.
Unique asset class
The portfolio manager believes that Nordic bonds "are a unique asset class, which requires a local approach. More than half of the companies in the Nordic countries are unrated, and many of these bonds are in the crossover segment (between BBB and BB ratings) that tend to offer a higher risk-adjusted return compared to European bonds."
Also making it unique is that the Nordic market has no benchmarks for international passive asset management investors. Furthermore, the market is dominated by steady, local investors with a "buy and hold" view. As a result, asset volatility is normally relatively low.
Moreover, in the case of Norway and Sweden, markets with local (non-euro) currencies, most Nordic corporate bonds are floating rate bonds, so they add very little duration to the portfolio compared to a benchmark European corporate bond.
Crossover segment
The strategy takes advantage of investing mostly in crossover bonds, those which straddle the line between investment grade and high yield. Pukka notes that this requires intensive fundamental analysis of the companies, hard work which can be rewarded with a premium obtained by taking advantage of valuation inefficiencies in the crossover segment. This is a high-quality, high-yielding segment in which some institutional investors cannot invest, as it is not strictly considered neither Investment Grade nor High Yield.
In fact, crossover is an inefficient "no man's land" where active asset management can add a lot of value, thanks to its ability to identify the optimal level of credit risk. And in the case of Nordic bonds, the lack of a benchmark also means there are no passive investors. What’s more, there have been very few purchases of Nordic corporate bonds by the ECB over the past ten years, as the Norwegian and Swedish bond markets have been left out of its purchase program. And finally, the default rates in the Nordic countries are very low.
Better access to funding
Nordic companies have traditionally been financed through equities and bank loans, and more recently in the public corporate bond markets. Most investors, both in equities and in bonds, are institutional investors with a long-term horizon, and they know the companies they invest in very well. This is why they don’t need to get credit ratings to raise liquidity.
However, more and more large Nordic companies are operating internationally, and regularly launch large corporate bond issues, often in excess of EUR 500 million. These companies do apply for credit ratings to help raise funding. Even so, 35 percent of the total market capitalization of the Nordic bond market is still unrated, which is a key reason why this asset class contributes an additional 50-150 basis points relative to its European comparables.
According to Evli, this spread is not due to lower liquidity, which was felt at the height of the pandemic. Finally, Nordic companies provide a lot of information to the market, especially those listed on the stock exchange. In general, data quality and transparency are high priorities for Nordic companies.
Large and diversified market
At the end of 2021, the market capitalization of this segment, excluding the financial sector, was EUR 290 billion (2015: EUR 192 billion) and growing. In comparison, the High Yield and Investment Grade markets in euros have a capitalization of close to EUR 390 billion and EUR 1,815 billion, respectively.
Issuers have grown from 430 in 2015 to 525 in 2021, with a large diversification by sector and size. Issues above EUR 250 million represent around 60 percent of the market, and "medium-sized" issues between EUR 100 and EUR 250 million, around 20 percent, excluding government debt and the financial sector. There is also a variety of maturities, although most of the bonds available have maturities between 1 and 3 years. There’s also diversification in terms of currencies, this segment having the currencies of four countries.
Currency exposure and ESG
Currency exposures are fully hedged at the fund level, but different currency areas within a portfolio enables great diversification in terms of sectors, economies, and the use of monetary policies, all of which combine to provide stable returns over credit cycles.
The Nordic countries have always been at the forefront in terms of ESG issues. Along with the Dutch, the Nordics were early adopters of ESG criteria. Thus, ESG matters are clearly taken into account when investing in Nordic bonds, since most companies have been doing it for years. When a company issues a bond, it usually already provides a comprehensive ESG questionnaire.
Evli's Nordic bond strategy
The Nordic bond fund manager Evli is well known for its broad expertise in investing in bonds, especially Nordic bonds. Around 70 percent of the total AUM of EUR 16 billion is invested in Nordic and European bonds. Its asset management activity is focused on institutional clients, which ensures strict compliance with the requirements of the largest investors in terms of transparency, reporting and sustainability.
Since 2014, Evli has been providing Nordic bond strategies to European investors, with a single comprehensive regional approach, rather than on a country-by-country basis. Within this range of strategies, the most relevant are those that invest in the crossover segment, which can be considered either as a complement to the Investment Grade portfolio or as a more conservative part of a High Yield portfolio. And as they are in many cases floating rate bonds, they are sometimes even considered as proxies for the money market.
"Given that short-term interest rates have already risen considerably and probably have little room to rise further, and spreads are at elevated levels, the time may currently be ripe for building an investment position in Nordic bonds" says Juhamatti Pukka.
Original interview published in Dutch in Financial Investigator issue 4, 2022.
