Market Views: Fixed Income

Record EMD asset class flows show shift in hunt for income

In this era of unprecedented asset price movements, we think investors should adapt their mindsets: they would be well served not to think of emerging markets as emerging markets.

18/07/2016

James Barrineau

James Barrineau

Co-Head of Emerging Markets Debt Relative

Bonds in developed markets have become, nearly quite literally, reward-free risk.

Spotlight on income

With that unprecedented development, investors are now sharpening their focus on finding where the highest probability of achieving sustainable income lies. Clearly, that probability currently lies outside of Europe, Japan, and the US government bond complex.

The sheer size of that complex means that as investors intensify the search for income and find alternatives, the resulting flows will mean yields will come down within those alternatives.

The past two weeks of record inflows into emerging market debt (EMD) mutual funds suggests this phenomenon is well underway. Indeed, EMD cumulative flows are now at four-year highs, with flows at +13.7 billion for 2016 so far, compared to -$14.4 billion and +11.1 billion in 2015 and 2014 respectively (according to data from EPFR and JP Morgan, 14 July 2016).

Flow flurry feeds EMD

The history of the EMD asset class shows that when markets respond in this way, risks come down: foreign exchange reserves rise, currencies stabilise or appreciate which leads to lower domestic interest rates, funding costs fall and debt is re-financed at more attractive levels, and growth prospects rise as a result of all of this.

Because of this virtuous cycle, investors and potential investors who attempt to divine "how far markets have run" or where "fair value" is are investing by guessing.

We have seen this again and again over 26 years in emerging markets. The only successful approach is to watch historically reliable indicators that the positive trends remain and to follow them as long as they do, and hoard attractive income opportunities that are already held.

The only difference in the current cycle is the absolutely unprecedented nature of the potential flow size given the destruction of income opportunities by global developed market central banks.

So, it is reasonable to postulate that historical valuation measures will prove poor indicators and emerging market income opportunities should continue to look very attractive.