GLOBAL - Pension funds are increasingly seeking to increase exposure to emerging market sovereign bonds at a time when credit ratings remain under pressure in developed countries, but emerging countries could also be impacted by the crisis in Europe and the US, First State Investment (FSI) has warned.

According to Helene Williamson, head of emerging market debt at FSI, the investment case for emerging market sovereign debt will continue to strengthen, with pension schemes looking to increase allocations to this asset class more and more.

"Emerging nations are now in a much stronger position to service their debt obligations than the world's advanced economies," she said.

"We expect this to become even more pronounced over the next few years as emerging economies remain supported by their good fiscal positions, relatively low financing needs and favourable demographics."

While the level of debt in advanced economies is expected to reach 100% of GDP this year, emerging markets' average debt-to-GDP ratio currently stands at around 34%.

Advanced economies, with their ageing populations, also have to cope with rising pension liabilities, which are not included in debt-to-GDP ratios, but are increasingly taken into account by credit rating agencies, according to Williamson.

Most emerging markets, however, have younger populations and enjoy a 'demographic dividend', as well as higher growth rates.

"Their financing requirements are also considerably lower than those of advanced economies," Williamson added.

"The strong ability of emerging markets to repay their debts is reflected in their improving credit ratings, and this trend is set to continue."

Emerging markets countries' ratings have improved since 1994, when the average rating was BB-. By 2010, the average rating had moved to BBB-, which is considered investment grade.

Meanwhile, developed markets have seen some downgrades, including the US and some European countries such as Greece, Italy and Portugal.

However, the financial turbulence in Europe and the US could also have a deep impact on emerging markets, Williamson said.

"Despite their own fundamentals remaining strong, emerging markets are not immune to occasional contagion, which was why emerging market bonds sold off in September on heightened market nervousness about Greece, Italy and the European banking sector," she said.

Earlier this month, a survey conducted by JP Morgan Asset Management found that institutional investors were seeking to maintain or increase allocations to fixed income before year-end, as the euro-zone crisis had also "created new opportunities" for fixed income investors.

Some schemes, such as French pension fund UMR, are now looking to invest in French, Italian and Spanish government bonds as part of its plan to increase risk exposure, targeting higher returns.

In addition, JPMAM also expects emerging market debt to become more important in the coming months, as European institutions seek ways to diversify their risks.

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