US investors prop up emerging equity flows
U.S. mutual fund investors are ploughing on with bets on emerging market equities, according to the latest net flows numbers from our corporate cousins at fund research firm Lipper. Has no one told them there’s supposed to be a massive sell-off?
August was the 30th straight month the sector has seen net inflows, and the 9th straight month of net inflows above $1 billion. Sure, there’s a downward trend from the February peak, but the resilience of demand is notable given doom-laden headlines about how EM markets will fare once the Fed feels its generosity is no longer required.
Of course, the popular image of mutual fund investors is as a perennial lagging indicator for allocations trends, and the stage may be being set for a sharp turnaround this month. However, U.S. investors have already been offloading their bets on emerging debt, with funds in the sector seeing net outflows of $2.6 billion, or 7.5% of total assets, in the three months to end-August.
It may be that this is part of a trend towards international diversification in the U.S., with investors taking a longer view and a more sanguine approach to risk. But they’ll need strong stomachs. Three-month performance at those U.S.-domiciled EM equity funds is at -7.7% (see chart below), while three-month net inflows are at more than $4.5 billion. Juxtapose that with the global EM equity sector over the same period, where average fund performance is at -8.2% and net outflows are a chunky $7.8 billion. In short, investors elsewhere are pulling cash out of emerging equity funds but U.S. fund buyers seem to be going the other way.
Chad Cleaver and Howard Schwab, emerging markets fund managers at U.S. fund firm Driehaus Capital, reckon the data simply reflects some clear incentives for American investors to stick with EM. They told us:
Firstly, profits from the US equity market can be redistributed into cheaper/lesser performing asset classes. Secondly, US investors/institutions have an unreasonably high percent of money in bonds. A reallocation of bonds assets, even in a small part, can create flows for emerging market equities.
Lastly, US investors are reasonably more positive/confident in global growth… and hence identify the cyclicality of emerging markets as an eventual beneficiary of this phenomenon.
They also highlight that lure of real diversification as we move away (investors hope!) from a risk-on, risk-off world.
While the composition of emerging markets may change… the overall opportunity within emerging markets remains highly differentiated from the economic/company fundamentals of more developed countries.
It may also be instructive that many of the U.S. mutual funds showing the strongest inflows are actually targeted at institutions. As developing nations’ stock markets are hammered by fears over the impact of Fed tapering, so major investors with emerging markets allocations targets to maintain will be engaged in a race to top up their holdings.
With this in mind, it’s useful to note that thanks to tumbling markets the total assets of the U.S.-based EM equity funds which have published August data have still fallen month-on-month, despite the net inflows. This cohort of funds have seen total AuM fall from $115 billion at end-July, to $113 billion at end-August, proving that even diversification, growth bets and allocation technicalities can’t keep a good downturn down.
(NOTE: Not all funds have published data for August as yet. The data from U.S. funds is based on about 150 funds out of 240 in total. The funds used represent about two thirds of the assets held across the whole sector. The Global EM funds data is drawn from about 800 funds vs a total sector made up of about 1,100 funds)