It seems that week after week, investors are allocating increasing amounts of investment capital into emerging market funds in both equities and bonds.
EPFR Global, a leading provider of fund flows and asset allocation data to financial institutions around the world, reported that emerging market equity funds had received an inflow of $2.2 billion for the week to August 2. In the same period, emerging market bond funds received $1.9 trillion.
The flow analyst firm stated that for 2017, on a year-to-date basis, the two asset classes for emerging markets had received inflows of some $90bn as 20 consecutive weeks of gains have been recorded.
This enthusiasm for emerging markets can in large part be traced back to low interest rates across the developed world and the ongoing weakness that has gripped the US dollar.
The dollar index has fallen by 8.84% since the start of this year.
The final frontier
Another sometimes overlooked reason for the increases in inflow is that while many fund managers have taken the decision to wade deeper into “exotic” markets territory, they have always drawn a line between “emerging” and “frontier” markets.
This year has seen Pakistan gain promotion from frontier to emerging-market status and as a result its global emerging market equity fund weighting has risen. This pattern looks set to continue, for while Argentina has not yet been promoted it will not be long before the second-largest economy in South America is elevated to emerging market status.
The same will be true for Saudi Arabia, although the prospect for oil-rich but strife-ridden Nigeria is not so certain.
MSCI has also boosted the potential for emerging market funds inflow as it agreed in June to add stocks listed in mainland China as well as Hong Kong-listed Chinese stocks. It added 222 China A-shares to its MSCI Emerging Markets index as part of the annual reclassification process.
The 222 large-cap stocks added will account for 0.7% of the weight of the MSCI emerging markets index; inclusion will occur in stages in May and August of 2018.
Similarly, as oil prices appear to have stabilised Russian equity funds finally ended an eight-week decline despite the latest push for sanctions from the US.
As a result, the MSCI emerging market stock index has climbed over 23% this year. This performance can be corroborated as at Spotlight Indices our measure of developed market equities less emerging markets has fallen by a staggering 32.96%.
The chart below shows that the differential has been locked in a downturn since mid-2015:
Source: Spotlight Indices
Fixed income, not so fussy
Success in frontier markets could mean high returns for investors. Equity investors may not feel informed enough to make educated decisions because there are not enough data to populate sophisticated financial models, but the story is different in fixed income bonds.
It is now common knowledge that emerging markets have provided favourable return benefits for many investors. If emerging markets offer enhanced returns, then frontier markets are supercharged in this regard. The attraction can be found in the fact that frontier markets with their potentially high returns tend to be uncorrelated to the predominant trends of the more developed asset space.
Frontier markets are investable, but they are less developed, liquid, efficient, and accessible than emerging markets. Therefore, and in the wake of such returns, frontier markets are now viewed by bond investors as a viable option to build diversity and add alpha.
Iraq is one such option and the sale of a five-year, dollar-denominated bond at a yield of 6.75% attracted $6.6bn worth of orders. Equity investors may raise an eyebrow as the country is in the grip of a civil war, but the message appears to be that oversubscribed risky sovereign bonds have become almost normal.
FI: fixed income or foolish investment?
In June, Argentina was oversubscribed for its 100-year eurodollar bond even though it is well known that Argentina defaulted on its debts six times in the previous century, the last time being in 2014. Other issuers this year have been Egypt, Ivory Coast, Nigeria, and Senegal – none of whom are remotely close to investment grade.
I have long advised investors to be wary of debt issuance from the comparatively safe Greece and so my stance on these insurers is even more clear... however, one cannot ignore the trend. What I would point out is the fact that Ivory Coast issued a bond in 2010 in lieu of unpaid debts. It then proceeded to miss an interest payment the following year and yet the investors keep coming back for more heartache.
Still... we are all adults and surely have our eyes wide open.
Fixed income opportunities await. Photo: Shutterstock
— Edited by Michael McKenna