The subject of decorrelation is one that continues to rumble on. But is there a case for the Nordics decorrelating from their European neighbours?
It is well-known that people are always looking for decorrelation themes when it comes to their portfolio; indeed, that is why you have a portfolio manager. However, as various countries announce their fortunes across the European continent, the natural question that will be asked in this part of the world and beyond is: can we argue that the Nordic countries bring decorrelation, e.g. as a part of a European allocation.
While individual European heavyweight economies announced differing Q1 GDP figures – Germany reported growth in Q4 of 2020 but has since seen a drop of 1.7% this year, while France reported growth this year – of 0.4% – but negative growth at the end of last year – the Eurozone announced an overall decline of 0.6%.
Of course, the Nordics are integrated with Europe, so it is a bit of a push to suggest that they are entirely decorrelated. However, there are three main arguments that point to a certain degree of decorrelation. Let’s take a look at them.
1. GDP composition
The Nordic countries tend to have a high degree of imports with each other and northern Europe, thereby making the import/export market fairly reciprocal. Indeed, if we remove Germany from the equation, a substantial percentage of trade takes place within the confines of the Nordics. This, alongside the fact there is higher GDP per capita if the Nordics are viewed as one trading entity, paves the way for a certain amount of decorrelation. E.g. the share of Swedish exports to Norway was 10% and to Denmark and Finland 7% each in 2019.
Another trade-related aspect that stems from this is the fact that the Nordic countries are not as impacted by what goes on in southern Europe or the Chinese behemoth to the east. Therefore, there is some decorrelation from global growth as well.
However, can we view this as decorrelation? This is a fundamental question that does not have a clear answer. In terms of GDP, it is perhaps true that we can make this point. For certain companies, GDP provides some leeway with regards to how profits are made within the company. By selecting the right combination of Nordic companies that deal in ‘bolted-to-the-floor’ industries, such as import/export, trade and real estate, decorrelation can be found.
2. Innovation and value creation
In terms of allocation, placing part of a portfolio in the Nordics is often advisable due to the strong innovation in the region. It can be seen as ‘out-of-the-box development’ of a portfolio. Innovation in the Nordics is very much alive and it is being listed. As a result, this brings increasing asset value, regardless of how the economy is doing at any given point – in other words, if you invent something it will be desirable.
There is also a much higher rate of innovation in the Nordic region. This is not to say it is not happening in other parts of Europe or the United States, while it is actually higher in the UK, but the difference being that it is not being collected or talked about as much.
This is especially true of the Swedish small-cap market, but why is this the case? It could be as simple as poor and myopic marketing. Nobody needs to talk about it on a national level, but rather on a country level. The statistics available need to be taken and blown up so that everyone can see them.
This successful innovation platform is also creating value. It succeeds here due to a high level of education and the social security that can be found in each individual country. People are more able and willing to take risks, because they know they will not become desolate if success does not come their way. Higher pension income and welfare payments mean that people have more leeway to be risky.
Will this innovation decorrelate your portfolio? Most likely, but this is only to be encouraged.
3. ESG
ESG in the Nordics is well-established and has been for all of the 2000’s. Further, it is backed by society through stronger competition and a lack of bribery. This, in turn, equates to decorrelation, given a higher quality of ESG plays out in more stable returns. However, this is not to say that the Nordics goes its own way; decorrelation in the region is still a matter of margins. In fact, the only thing a portfolio manager can do is chance the portfolio on the margin.
The Nordics weigh 12-15% in European equity indices. For Evli, this is a good thing. However, to look deeper into the issue, Evli funds – specifically in the Swedish small-cap market – have returned more over the last ten years than emerging markets. Having less decorrelation than others in your portfolio will actually reduce risk, as corporations can produce more stable returns.
By including Nordic equity and corporate bonds to your European portfolios, you’re able to enjoy the decorrelation from the Nordic markets in your allocation. You can invest successfully in the world’s most developed economies – economies that have returned better than emerging markets.
By applying these three features, it is possible to see that there is a certain amount of decorrelation when it comes to the Nordics. The fundamental make-up of the countries under this banner means that decorrelation becomes not only inevitable but welcome, with investment producing stable returns over a long period of time.
Petter von Bonsdorff
