Russia’s invasion of Ukraine has sent jitters through bond markets in the Baltics and Finland, and deterred international investment in the region, as fund managers seek to avoid geopolitical risks.

Debt investors are shying away from Finland, Lithuania, Latvia and Estonia, and showing a preference for other markets further from the Russian border, said André Küüsvek, chief executive of the Nordic Investment Bank, which is backed by governments in the region.

“Larger bond funds — the more global funds — say it’s very difficult for them to assess how big the risk is,” Küüsvek said. “It’s easier to take a ‘wait and see’ attitude.”

Appetite for NIB financing started to grow before the war in Ukraine in response to higher inflation and rate rises from central banks, and has increased in 2022, Küüsvek said.

The NIB agreed €1.2bn in loans in the first quarter of 2022, almost five times the amount in the same period of 2021, and an increase of more than 25 per cent on the previous quarter, with the bulk of its financing aimed at companies.

“It’s a combination of high inflation and rate hikes and the geopolitical uncertainties that have mostly affected [new bond issues] in the Baltics and Finland”, Küüsvek added.

The gap in yields between the region’s government bonds and the debt issued by companies has widened of late, reflecting a greater sense of nervousness.

In government debt markets, the yield on Finland’s benchmark 10-year bond has risen by around 0.8 percentage points since February 24 to 1.4 per cent, according to Tradeweb data. The spread, or riskiness of the bond relative to Europe’s benchmark 10-year German bond, has widened from 0.36 percentage points to 0.46 percentage points over the same period.

Line chart of Spread between 10-year Finnish and German government bond yields showing Investors demand higher premium for holding Finnish debt

Nicolas Forest, global head of fixed income at asset manager Candriam, said he had downgraded the countries and disinvested, flipping instead to other countries in southern Europe where yields are similar but geopolitical risks are lower.

“If I look at Latvia and Lithuania compared to Spain, does it make sense to invest in a very small country, dependent on Russian oil, when there is an alternative with a similar level of yield in a bigger country?” Forest said.

Concerns for bond investors extend to elsewhere in eastern Europe, said Tatjana Greil Castro, co-head of public markets at Muzinich, an investment firm specialising in credit.

“All those companies that operate out of Romania, Bulgaria and central and eastern Europe have been suffering from the closeness and the potential spillover,” she said.

The difficult wider picture for bond investors, with returns reaching 20-year lows across European corporate credit markets and the long-running government bond market bull run coming to an end, have also contributed to negative sentiment among traders, Greil Castro said. “If you’re in a negative mental state, you see risks and drama everywhere and the [spilling over of the war] is an easy one to focus on.” 

Low liquidity in Baltic state bonds is likely to be further hit by plans from the European Central Bank to phase out bond buying in the months ahead, said Anton Hauser, a fund manager at Austrian asset manager Erste AM, which manages $76bn and focuses on central and eastern Europe.

Although he said some investors had sold Baltic state bonds because of geopolitical worries, “most bonds are sitting in portfolios of locals who know the situation well. There’s no big problem with sell-offs.”

The challenge is one of perception from international investors rather than reality, Küüsvek added. “If anything, security is actually better than it was in January because the reality has kicked in and the readiness and awareness is much greater.

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