Runaway Property Prices Put Swedish Investment Funds at Risk

  • Money flowing out of corporate bond funds, Swedbank says
  • Real estate companies now biggest group of debt issuers

A Swedish real estate crash would be very quick to spread beyond just affected borrowers and banks.

That’s because of two factors: property and construction industry companies have emerged over the past five years as the biggest group of issuers in Sweden’s growing corporate bond market, and the single biggest holders of those securities are mutual funds, according to Swedbank AB.

The concentration of ownership in funds whose customers can pull cash out poses a risk to investors and to companies. And movements are now going in the wrong direction, with money flowing out of corporate bond funds for the first time in almost two years, according to the bank.

While the outflows aren’t very large now, “the question is, will the market function if the system is shocked?” said Linus Thand, chief credit strategist at the Stockholm-based bank. “If outflows pick up, everyone will try to get through the door at the same time.”

The International Monetary Fund earlier this month highlighted the problem in its Global Stability report. Mutual funds are “vulnerable to potential large-scale redemptions” and that may endanger market liquidity, the group said.

Inflated Prices

As Sweden’s central bank has cut rates to negative to revive inflation, pushing down borrowing rates, property prices are surging and debt burdens are growing. The National Institute of Economic Research is warning that in the absence of stronger efforts by the government to slow price momentum, the market probably will crash.

The potential hurt put on Swedes could be significant. The country has more savings invested in funds than any other, according to the Swedish Investment Fund Association. Swedes have tripled the amount they hold in mutual funds in the past decade, with the industry’s assets of 3.1 trillion kronor ($380 billion) now roughly equal to 80 percent of Sweden’s economic output. About a quarter of this is invested in fixed income.

The government is looking at measures to cool housing, and is seeking an agreement with the opposition to tighten amortization requirements.

The government wants a consensus on measures “so they’re not shifted in a couple of years,” Per Bolund, the minister for financial markets, said in an Oct. 12 interview.

Real estate companies increasingly resorted to the bond market as banks cut lending after the financial crisis. Property and construction companies account for more than 42 percent of issuers, according to an October 2014 report by the Swedish central bank.

In Demand

Investor demand remains high, said Martin Malhotra, a director at Catella. The Stockholm-based financial adviser and asset manager compiles an index of market sentiment on real estate company debt. It rose 2.1 points to 56.6 in September, amid a perceived improvement in financing conditions during the past three months. Catella polls lenders as well as real estate companies.

The bonds, which first appeared about five years ago, now account for more than 10 percent of companies’ interest-bearing debt, according to Malhotra. He said he’s not concerned about the increasing use of debt or Swedish investment funds’ holdings. To the contrary.

“The investment properties have increased in value through both appreciation and acquisitions,” Malhotra said. And local investors fortify the market, while “liquidity from abroad, e.g. funds in London, does spill into the Nordic and Swedish market in good times and typically dries up in bad times.”

More than half of the assets that the Swedish funds have under management is invested in equity, but holdings of corporate debt is growing as the market expands. Funds registered in Sweden hold about 35 percent of investment-grade real estate bonds, up from under 10 percent in 2012, according to Swedbank. The figure is likely to be even higher since it doesn’t include funds registered abroad, especially in Luxembourg, Thand said.

“I don’t want to paint too grim a picture, but we’re monitoring these signs to see where things are heading and keeping an eye open to see if things can go wrong,” Thand said. “It could have consequences for how the market operates: liquidity could just dry up completely.”

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