Institutional investors retained their allocations to emerging markets last year, despite poor performance, but the UK vote this week on whether to leave the European Union could be a turning point for these flows.

Mercer’s 2016 European Asset Allocation Survey said institutional investors have, in the main, retained allocations to emerging markets, despite a sustained period of disappointing performance since 2013.

Phil Edwards, European director of strategic research for Mercer’s Investments business, said in a statement: “It is encouraging to see institutional investors taking a long-term view in relation to emerging markets, in marked contrast to the behavior of retail investors since the taper tantrum in 2013. We continue to advocate exposure to emerging markets as part of a well-diversified growth portfolio.”

The survey found that emerging markets accounted for around 6% of overall assets, the same as last year, and that both emerging market equity and debt remain common components of institutional portfolios across Europe.

However research provider, the Institute of International Finance, warned in a note today that the Brexit vote may be a key pivot for emerging market flows. The UK is holding a referendum on whether to leave the European Union on June 23.

“A Leave vote would likely be followed by substantial short-term global market volatility and a surge in risk aversion, which would weigh heavily on portfolio flows to emerging markets,” added the IIF. “By contrast, a Remain vote could usher in a risk-on environment that would support flows into EMs.”

The IIF said that a surge in flows to emerging markets ended on June 16, the day after the Federal Reserve announcement which included concerns about Brexit. “From the day flows turned positive (May 27) to the last day of net inflows (June 13), the seven countries we track registered inflows of nearly $9.5bn, of which $5.3bn went into debt securities,” added the report.

Mercer also warned that on average, smaller UK pension plans are more exposed to any market volatility associated with the EU referendum as they tend to have a 30% allocation to UK assets, compared to 16% for larger plans.

Nathan Baker, principal in Mercer’s Investments business, said in a statement: “Although it’s not possible to know now with any certainty how the referendum will impact portfolios, a typical small UK plan is more UK-centric, more exposed to movements in sterling versus other currencies, and is managed in a less dynamic fashion. On balance, they would appear more exposed to any associated volatility, and less well positioned to take advantage of it.”

The Mercer survey also said institutional investors across Europe are reviewing their bond portfolios due to negative yields affecting their ability to meet and hedge their liabilities. Within institutional bond portfolios there has generally been a shift away from domestic government bonds to higher-yielding non-domestic and/or corporate bonds.

Mercer added that average equity allocations across Europe have fallen since the 2015 survey but there has been a corresponding increase in allocations to alternative assets. Baker said: “Many markets are suffering from reduced liquidity which creates volatility; investors should be alert to and set up to capitalize on opportunities that market volatility may create.”

The investment consultant added that one way to address the challenge posed by lower returns is to seek a greater contribution to portfolio returns from manager skill. “In particular, long-term investors should be able to capture relatively attractive returns in private markets, partly from illiquidity premia, and should be able to behave in a contrarian manner when market dislocations arise,” added Baker.

Mercer’s European Asset Allocation Survey gathered investment information from nearly 1,100 institutional investors across 14 European countries, reflecting total assets of around €930bn ($1,051bn).

Detlef Glow, head of research for Europe, Middle East and Africa at fund researcher Lipper, said in a note today that European investors continued in a risk-off mode last month and sold risky assets. As a result equity funds were assets with the highest net outflows in Europe, €10.3bn, in May while in contrast bond funds were the best-selling asset type with inflows of €7.8bn.

“This flow pattern drove the overall fund flows to mutual funds in Europe to net inflows of €15.2bn for May,” added Glow. “With these inflows the European fund industry returned to a growth pattern, enjoying overall net inflows of €34.2 bn over the course of 2016 so far.”

Glow said JP Morgan was the overall best-selling fund promoter for May with net sales of €4.8bn, ahead of BlackRock €4.3bn and Aviva with €3.5bn.

More on Brexit:

• Equity Market Braces for June 24, or ‘Brexit+1’
• Margins Raised Ahead of Brexit Vote
• Hermes Warns of Brexit Risk to Asset Managers

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