Freedom Is a Risky Place for Icelandic Investors Seeking Exit

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Iceland’s asset managers are champing at the bit for capital controls to be removed so they can invest more abroad. Yet what awaits them in the broader world may be sinking markets and falling currencies.

We “have to be mindful of the fact that some foreign markets are at an all-time high," said Bjorn Hjaltested, head of asset management at the Pension Fund for State Employees, Iceland’s largest retirement pool. "Also, is the krona likely to strengthen? We’re not hedged in the krona, so you might find yourself hitting the foreign markets at a peak and if the krona starts strengthening, it will hurt the return of the pension funds.”

That’s a conundrum for the nation’s pension funds, which are in need of diversifying their portfolios after being largely locked in behind capital controls for seven years. But it could also ease the government’s drive to loosen the restrictions next year by limiting pressure on its current account balance.

“So while it’s clear that the funds want to increase their foreign assets, it will probably happen in a much more prudent way than many think,” said Hjaltested, who manages 535 billion kronur ($4.1 billion) in assets.

Iceland imposed restrictions on its currency after the 2008 crash of its three largest banks plunged the nation into the worst recession since World War II. The controls are preventing investors from investing abroad and have helped the country’s main stock index more than triple in value and pushed the GAMMA index of Icelandic government bonds up more than 90 percent since early 2009.

The central bank in July started loosening controls a bit to ease the domestic pressure cooker, allowing pension funds to invest 10 billion kronur abroad. Governor Mar Gudmundsson said in October that bigger steps will be taken "early next year."

The Icelandic Pension Fund Association estimated in May its members would need to invest as much as 1 trillion kronur abroad over the next 10 years to be properly diversified.

Even so, potential gains in the krona may keep them at bay. The currency is up 9.3 percent this year, in part as investors snap up Icelandic securities to benefit from a so-called carry trade. Iceland’s central bank has been raising interest rates to cool growth and keep a lid on inflation, unlike the rest of Europe where rates are at rock bottom.

The krona is still about 60 percent below its average value running up to the outbreak crisis in 2008.

"So while it’s gained considerably lately and in comparison with these past few years, it’s still not very strong when you look at the long-term average of the real exchange rate," said Floki Halldorsson, managing director of Stefnir, Iceland’s largest fund management company, which has about 400 billion kronur under management.

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