It is one thing to be aware that a specific market sector needs to be developed. It is quite another to recognise that opportunity and to grasp it with both hands. In helping to grow the corporate debt market in the Baltic countries, and for its innovative approach to its own fixed income strategy, Hansa Pension Fund K3 has won the award for Best Fixed Income Investor.

For many years, the corporate debt market has been almost non-existent in the three Baltic countries of Estonia, Latvia and Lithuania. There are several factors behind this state of affairs.

First, the economies of the individual countries and of the region as a whole are relatively small. Many Baltic corporates have foreign owners, usually Scandinavian. And there had already been an ample supply of corporate bank loans.

As a result, the larger companies had little interest in tapping the local credit market via bond issues. And any investor in bond issues had to build up analytical capabilities and other infrastructure. So it was relatively expensive for potential investors to participate in small and limited offers. In other words, here was a classic example of market failure.

However, the existence of a domestic debt market was an attractive concept not only to Hansa Pension Funds itself, but for the entire pension system in the Baltic countries.

PARTICIPATING IN DEVELOPMENT
This is because investing in the local bond market, together with equities and real estate, enables pension funds to participate in the region's economic development, thus providing the best available match to their return targets, which are driven by the domestic factors of wage and price inflation.

Hansa - a compulsory second pillar pension fund for Estonians - is by far the largest pension fund in the Baltics, with a €150m portfolio. As such, Hansa realised that it was in a good position to galvanise the local corporate debt market into life. Of course, part of the impetus came from self-interest: the prospect of helping to create assets which the fund could then invest in to reap a good return.

The first step in encouraging the growth of local corporate debt issues in this small and illiquid market was to issue a strong signal that demand conditions had improved.

This was achieved in early 2006, by allocating a portion of Hansa Pension Fund's assets to a single pooled portfolio. The pension fund then informed potential arrangers across the Baltics of the arrival of this new counterparty, which was far bigger than any others in existence.

UNIQUE SCALE
The size of the potential investment that Hansa was able to commit was totally unique in the Baltic corporate debt market. Hansa's systematic approach as an investor, as well as its focus on individual issuers, was also unheard-of.

At the same time, financial market conditions started to become more favourable for corporate bond financing. This was because, after several years of excess supply, the banking sector had started to tighten corporate lending conditions.

Hansa's entry into the market as its largest investor, and the change in the financial climate, led to a rapidly increasing interest for bond financing from the corporate sector.
As an indication, the number of corporate bond issues in the Baltics during the first half of 2007 was around four times as many as the number of issues the previous year.

The attempt to activate the corporate debt market was far more successful than Hansa had ever expected. Because of this success, and so as to create a more transparent and predictable counterparty, in summer 2007 a new and independent Corporate Debt Fund was formed from the pooled portfolio of Hansa Pension Fund.

AWAKENING MARKET
The awakening - not to say creation - of the Baltic corporate debt market has yielded a number of benefits, both for Hansa's own investment activity and for the regional pension system as a whole.

First, the domestic corporate bond fund has become an attractive investment vehicle for investors - including many Baltic pension funds - who previously had little interest in participating in small individual bond offers.

Furthermore, over 60% of the fund's assets (around €30m) are now contributed by external investors, so for Hansa Pension Fund, the vehicle has become a source of significant extra income in the form of fees.

Another benefit is that Hansa has become by far the most influential player in the local debt market, buying around 40% of new issues. This gives it significant power in determining conditions for corporate bond issues. It is now common, for instance, for companies to discuss potential terms and conditions with Hansa at the stage of issue arrangement.

Hansa has also forced the improvement of reporting standards and collateral agreements of new bond issues.

There have also been straight financial benefits for the pension fund. The liquidity of the local bond market is still low, so by exploiting this in its capacity as a virtual monopoly, Hansa has managed to increase the spread (adjusted for credit rating) of its local corporate bond portfolio by 200 basis points over Euribor (yield to above 10%).

Finally, Hansa's participation in a large number of bond issues has substantially increased its understanding of the Baltic business cycle, which is important in helping it analyse the future performance potential of other domestic asset classes.