The people buying emerging markets

July 23, 2014

We’ve written (most recently here) about all the buying interest that emerging markets have been getting from once-conservative investors such as pension funds and central banks. Last year’s taper tantrum, caused by Fed hints about ending bond buying, did not apparently deter these investors . In fact, as mom-and-pop holders of mutual funds rushed for the exits,  there is some evidence pension and sovereign  wealth  funds actually upped emerging allocations, say fund managers. And requests-for-proposals (RFPs) from these deep-pocketed investors are still flooding in,  says Peter Marber, head of emerging market investments at Loomis Sayles.

The reasoning is yield, of course, but also recognition that there is a whole new investable universe out there, Marber says:

There has been so much yield compression that to get the returns investors are accustomed to, they have to either go down in credit quality or look overseas. Investors have been globalizing their equity portfolios for 25 years but the bond portfolios still have a home bias. We are starting to see more and more institutional investors gain exposure to emerging markets, and a large number of recent RFPs highlight more sophisticated mandates than a decade ago.

The allocation swing has been especially marked since the 2008 crisis and subsequent Fed money printing that flattened yields across developed markets – the IMF estimated earlier this year that of the half trillion dollars that flowed to emerging bonds between 2010-2013, 80 percent came from big institutional investors.

Here is a chart provided by the Institute of International Finance that shows the stark contrast between retail and institutional investors’ emerging market holdings:

Here are some of the IIF’s findings:
A) allocations of institutional investors in the mutual fund sector are now over 7.5 percent higher for emerging bonds and 9 percent higher for equities compared to last May.

B) adjusted for price changes, institutional investors’ mutual fund allocations to EM (both debt and equity) in dollar terms are more than three times as high as they were in 2007.

C) a mid-2013 survey of a small sample of insurance companies from developed OECD countries found them to have EM debt investments of $4.5 billion, compared to $0.5 billion in 2005.

D) a fifth of EU pension plans had specific allocations to EM equities in 2012, up from 17 percent in 2010, while EM debt allocations were close to 11 percent, up from less than 2 percent in 2010.

So how much money are we talking about in total? While the mutual fund industry worldwide is estimated to have $29 trillion under management, institutional investors (pension funds, sovereign wealth funds and insurance firms) manage around $76 trillion, the IIF says. And only a tiny fraction of that – well below 5 percent –  is allocated to emerging markets at present.

There could be some pullback – because of a lag between awarding a mandate to a fund and actual investment, a lot of the cash that’s been coming through of late would have actually been allocated late last year. Some pension funds have also trimmed their emerging market holdings – the Ontario Teachers plan for instance cut its $1.6 billion bet on emerging equities via a Blackrock ETF by more than two-thirds earlier this year. But others, from Japan’s $1.2 trillion government pension fund to Norway’s $850 billion giant, are among those which recently appointed fund managers to oversee new emerging market investments.

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