Stockholm (HedgeNordic) – Sweden’s buffer fund, AP3 Tredje AP-fonden, made the decision to divest all of its equity exposure to emerging markets in 2022 following Russia’s invasion of Ukraine. This proactive move paved the way for the development of a political risk analysis model aimed at guiding investments in emerging markets. Jonas Thulin, who took on the role of Chief Investment Officer at AP3 in early 2024, is enthusiastic about reintegrating emerging markets into the fund’s portfolio this year.

“As we analyze global growth momentum, it’s quite clear to us that we are still experiencing this great rebound that has persisted since the summer of 2022,” notes Jonas Thulin, known for his data-driven perspective on investments. “From a quantitative standpoint, it’s been relatively smooth sailing across the globe. Despite some areas of weaknesses observed in Europe or Sweden, for example, recent data indicates positive development in Japan, the United States, and certainly in emerging markets,” he elaborates. “I’m quite keen to get moving on these investments because there’s certainly some value to be caught in emerging markets.”

“I’m quite keen to get moving on these investments because there’s certainly some value to be caught in emerging markets.”

Thulin, however, shares reservations regarding the term “emerging markets,” noting, “It’s a somewhat tired, old-school label, and I’m not entirely convinced about how ‘emerging’ these markets truly are.” He emphasizes the importance of focusing on the right countries in this emerging markets universe, stating, “What’s more critical for us is to identify the right countries based on our new framework, which evaluates the state of democracy, rule of law, corruption, legal and human rights perspectives.” 

“What’s more critical for us is to identify the right countries based on our new framework, which evaluates the state of democracy, rule of law, corruption, legal and human rights perspectives.” 

AP3’s political risk analysis model evaluates countries based on standardized metrics such as democratic governance, practices related to arbitrary arrest and detention, judicial independence, human rights, and corruption. “We source data on these metrics and try to identify the countries that meet our threshold for investment,” explains Thulin. “While the exact threshold may evolve, we currently have a solid understanding of what our requirements for investments will be at a later stage.”

After pinpointing suitable countries for investment, the next phase involves selecting appropriate investment vehicles and AP3 has opted to utilize actively managed funds for this purpose. Large allocators such as AP3 often opt for the “active manager” route to gain access to the often opaque and volatile world of emerging markets. Active managers can leverage their on-the-ground insights and rigorous research to identify promising opportunities and more importantly, mitigate risks. “While we may consider using actively managed ETFs, standard ETFs, or single stocks in the future, we’re initially opting for a more traditional mutual fund approach,” explains Thulin. “This decision is driven, in part, by the ease of conducting due diligence, as we can directly influence the geographic focus of the investments.”

“While we may consider using actively managed ETFs, standard ETFs, or single stocks in the future, we’re initially opting for a more traditional mutual fund approach.”

Thulin further acknowledges that historically, AP3 has lacked the necessary expertise and resources to conduct comprehensive country and company analyses within emerging market equities. “We identified where we want to be exposed with our commitments, and the managers we partner with will tailor to our mandate accordingly,” says Thulin. This represents just the initial phase of a continuous development process, notes Thulin. “We anticipate adding additional layers and refining our approach over time.”

Data-Driven Mindset

The challenge of inadequate data about emerging countries and companies poses a significant obstacle for large institutional investors seeking to allocate capital in these markets directly. “As someone who values data-driven decision-making, I want to see more and more data, more and more analysis both from a strategic, but also from a tactical point of view,” says Thulin. The newly appointed CIO of AP3 goes on to emphasize that the concept of emerging markets is vast and ambiguous, and the process of investing in emerging markets requires “constant work on improving and honing in our skills, not only on a country level but also on a sector or company level,” he continues.

“As someone who values data-driven decision-making, I want to see more and more data, more and more analysis both from a strategic, but also from a tactical point of view.”

While assessing company fundamentals is important, investors such as AP3 are placing growing emphasis on sustainability factors, including environmental, social, and governance aspects, according to Thulin. “Today, we want to work in a more and more sustainable manner, which involves grasping the environmental, social, and government aspects and everything else that comes with these aspects,” explains Thulin. He highlights that this is an area where the challenge of inadequate data is particularly pronounced. “Accessing reliable data for emerging markets is more challenging compared to the US and Europe, where data availability is more robust. Finding trustworthy data sources is a critical aspect of our work.”

For a data-driven investment professional such as Thulin, high-quality data becomes paramount. “We need to bridge those gaps to make the analysis and right call in emerging markets,” elaborates Thulin, who acknowledges that “obtaining accurate and reliable data from appropriate sources can be an uphill battle.” Thulin also points out that the prevalence of traditional economists or strategists is dwindling in favor of more quantitative analysts, both in strategic and tactical roles. “That’s the right way to go. At the end of the day, with our mandate, we need to make sure that we fully understand and can control our investments. It’s not enough to be a storyteller anymore. We need to find proof and data.”

Percentage Allocation to Emerging Markets

After having divested all its equity exposure to emerging markets in 2022, the exact allocation of AP3’s SEK 500 billion investment portfolio to these markets remains uncertain. Thulin notes that emerging markets typically constitute around 11 percent of the global benchmark but emphasizes that AP3 will not immediately allocate 11 percent of its equity exposure to this universe. “Let’s say that we are half right and we start to see some interesting moves in emerging markets. We will probably need to evaluate our approach to increasing our exposure in a constructive and collaborative way.”

“We can see an opportunity, we can see great value added for the Swedish pension system.”

Thulin concludes by highlighting the potential and significant value these markets could bring to the Swedish pension system. “We can see an opportunity, we can see great value added for the Swedish pension system,” notes Thulin. He explains that while their strategic choice is to include emerging markets in their portfolio, the allocation will also involve a tactical overlay that reflects factors such as momentum, valuations, and risk-adjusted returns. “While our process of investing in emerging markets has a solid foundation, we can strengthen the process and we will never stop building.” 

Picture by Peter Phillips