Emerging Market Outflow Double 2013 Levels

Investors have picked up the pace of buying in emerging market securities in the week ending April 2, but equity outflows this year are more than double where they were in 2013.  Since Fed talk of tapering last May, coupled with fears of a China slow down — again — investors have been wary about buying corporate stocks outside of the core economies.

The good news is that dedicated emerging equity and bond funds managed to register their first week of inflows since late last year, according to EPFR Global, a fund tracking firm in Cambridge, Mass.  The equity inflows were particularly noteworthy because they were the highest they’ve been since October.  The price action and the mood may have turned for the better, but given the long period of outflows and emerging market economic growth leaving little to be desired, Barclays Capital analyst Koon Chow in London said investors may need “a couple more weeks of positive flow numbers” to confirm a trend.

For now, the MSCI Emerging Markets index is close to erasing all of the losses incurred since the tapering news hit full swing last May. From May 31, 2013 to April 4,  the index is down just 0.5%.

Emerging market equity funds got a fresh $3.07 billion in the week ending April 2, EPFR Global said. Asia continues to be a sore spot and is still registering outflows. In one week, Asia equity funds tracked by EPFR lost $730 million.

Emerging market bonds faired better, with fresh inflows of $1.06 billion into dedicated bond funds, most of it into hard currency bonds that don’t have the currency risk.

So far this year, over $35 billion has flown out of emerging market equities, up from $14.05 billion at this time last year. Asia is in the worst position, with outflows this year of $12.97 billion versus just $400 million last year.  In the bond market, $11.9 billion has been pulled out of emerging debt funds. But that’s better than the $14.04 billion at the same time a year ago.

“At some point investors will get over their fear of emerging market debt,” said Wes Sparks, a portfolio manager at Schroders, a $435 billion asset management firm based in London.

The combination of still-helpful technicals, pockets of high local yield, cheap valuations versus developed markets in emerging market credit and new evidence of current account improvements, primarily in India, favors more bullish trades, BarCap emerging markets fixed income analysts said in a note to clients today.  Their favorite currencies are the Indian rupee, Brazilian real and Indonesian rupiah.  All three have strengthened by more than 2.5% against the dollar year-to-date, with the rupiah up by more than 6%.  Barclays says elections in Indonesia and India, in particular, are not a major risk to bond markets.

“Emerging market bonds, as well as currencies, continued to do well, helped by investors taking a ‘balance of risks’ view on emerging to turn more positive,” Barclays’ team led by Koon Chow wrote in their emerging markets weekly report today.

Emerging market bond investors will be keen on watching U.S. Treasury rates, and will pay close attention to further thoughts on tapering by Fed Chairwoman Janet Yellen.

U.S. Treasury market stability is a key assumption for further gains in emerging markets.  Barclays’ view on Treasurys is another rise in the Treausury yield will come in the second half of this year. At that point, it will be difficult for emerging market fixed income and currencies to ignore it because it will have negative effects through a number of channels — including funding costs for businesses.

For now, “we are still in an environment where emerging market sensitivity to Treasury yields will be low because the levels themselves of Treasury yields are not at range extremes,” said Chow, noting that further increases in Treasury yields would make investors switch back to the dollar rather than risk it elsewhere, even if yields are higher in places like Brazil.

The debt markets are the preferred way fund managers add emerging market risk to a portfolio.  Most of the bonds are only available to institutional investors, carrying hefty initial investments upwards of a million dollars.

For institutions, Barclays likes the long end of the curve and recommends Brazil 2025 local currency debt, Mexico’s and Colombia’s 2044 bonds.  In Asia, Philippine 2021s and Indonesian 2043s are buys.

Retail investors can also get a taste of higher yield, investment grade debt.

Anyone with an E-Trade account and $1,000 can buy local currency emerging market debt. For instance, Brazil 2040 government bonds are available on the E-Trade platform. The risk with Brazil’s 2040s is that the bond is callable in 2015 at par value. It currently trades at around a 14% premium, meaning yield to call — should the Brazilian government pay off that bond issue sooner rather than during its maturity date on Aug. 17, 2040 — investors would yield just 2.66%, which is worse than a 10 year Treasury bond that yields 2.8%.

Investors have been shunning this bond market for that reason.

For instance, when Colombia issued a small BBB rated, 20 year billion dollar bond on Jan. 21, 2004, the government agreed to pay 8.12% interest in the local currency, the peso. But demand for yield was so great, that investors quickly put a premium on that bond, which currently trades at nearly 31% over par. That means investors are paying $1,310 for a $1,000 bond, which has pushed yield to maturity for Colombia’s 2024s down to 4.32%.

See: Janet Yellen’s ‘Most Dovish Speech Ever’ –WSJ

Best Emerging Market Bond Mutual Funds – U.S. News & World Report

Bill Gross’s Love Affair With Brazil Bonds Ends – Invest News

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