The screw has turned on international investments into emerging markets (EM) as the US Federal Reserve raising interest rates on one side and political and economic turbulence on the other side have caused investments to flow out of EMs and into mature markets ever since the start of this year.
“As the US dollar headed higher in May, investors pulled $6.3bn from EM funds, with bond outflows accounting for about two-thirds of redemptions,” the Institute of International Finance (IIF) said in a note on June 8. “This sharp retrenchment was in line with portfolio outflows seen in May. As a result, global fund investor allocations to EM bonds have dropped to their lowest level this year, below 11.5%.”
IIF says that the outflows are still not as big as after the results of the US presidential elections in 2016 but the flows are still “troubling.”
“While idiosyncratic country risks and rising trade tensions have been a factor, higher global rates and the stronger dollar appear to be the dominant drivers of late— underscoring contagion risk,” IIF said.
It has been clear for a while that the US Fed is now increasing interest rates again and has embarked on a new tightening cycle. That is bad news for emerging markets where investors prefer the improving returns in more traditional markets that have less risk. In the near-zero interest rate environment that has prevailed for years investors were forced to accept high risks because of their need to make some sort of returns. But now those conditions are changing those same investors are re-balancing their portfolios along more traditional lines, investing into lower risk assets that are now paying large enough returns to make it worth an investor’s while.
In this push-me-pull-you scenario the instability in several key markets has catalysed the flows. Turkey has been close to a full blown currency crisis and while Russia’s economy is doing pretty well, it remains the focus of high geopolitical tensions that have put investors off.
“The resilience in EM bond funds in 2017 was due in large part to very strong flows to local currency bonds — inflows that continued well into April of this year. Indeed, foreign ownership in EM local currency bond markets has been on the rise, particularly for Indonesia, Colombia, Russia and Czech Republic. However, fund investor demand for EM local currency bonds has been highly sensitive to currency swings,” IIF said in a note.
IIF also highlights that in the past investors have been discriminate in which countries they chose to sell, depending on the volatility of their currencies, amongst other factors. However, that has changed in the last month when all EMs have been sold off — even the former favourites.
“Fund flow patterns until recently have been characterised by a lack of selectivity, with both vulnerable and more insulated emerging markets hit by outflows from bond funds. Indeed, every EM country in our sample saw net outflows from dedicated bond funds in May,” IIF said.
This article provided by NewsEdge.