Big pension, insurance and sovereign funds may be scaling back investments in emerging markets amid disappointing returns and a darkening outlook for the sector.
These deep-pocketed funds — global pension assets alone are worth over $35 trillion — are relatively recent entrants to emerging markets, driven by the collapse in Western bond yields and the need for diversification. Because they are focused on the long term, their presence has been a powerful counterweight to skittish retail and hedge fund money.
Such investors have pumped at least $50 billion into emerging stock and bond markets since 2013, according to the world’s most closely watched monitor of capital flows to emerging markets, the Institute of International Finance.
But signs of a protracted growth slowdown and the prospect of years of lackluster returns may be causing some to rethink their strategy.
The IIF — which predicts the first net capital outflow from the developing world since 1988 this year — estimates that institutional sellers accounted for 75 percent of the $40 billion that has fled emerging markets since late June. (http://link.reuters.com/cac85w)
“We are seeing signs the latest outflows are being sourced by institutional investors as well as retail investors,” Charles Collyns, the IIF’s managing director and chief economist, said recently.
“During the taper tantrum it was retail that headed for the door,” he said, referring to the 2013 selloff driven by hints of an end to U.S. money-printing stimulus.
“Now we are seeing signs … that institutional investors are also capitulating, and that’s a bad sign.”
One London-based bond fund manager said flow patterns from his fund gelled with the IIF conjectures. Institutional investors sat tight in the first half of 2015 but have since accounted for at least half the outflows, he said, speaking on condition of anonymity.
Separate data from JPMorgan shows strategic investors — as the bank terms long-term institutions — have committed $17.4 billion to emerging debt in 2015, below the recent annual average of $25 billion.
While overall “strategic” flows are still positive for the year, they were negative in the third quarter for the first time since 2008 at minus $650 million, JPM said.
“Concerns over a loss of sponsorship have moved further into the forefront amid an escalation of fundamental concerns in EM,” the bank added.
Dimmer Outlook, Fundamentals
There are several reasons for this capital flight. Rather than a quick shakeout, funds fear that over-investment and over-borrowing problems in emerging markets may take many painful years to be corrected.
This may test the patience of even “sticky” investors such as pension and insurance funds which had hoped the sector would deliver the higher yields needed to meet liabilities that have ballooned as populations in the West and Japan age.
Instead they have seen emerging stocks and local currency bonds underperform developed peers for several years.
There may be other factors at play — funds from oil exporting nations, for example, are under pressure to liquidate overseas investments to plug deficits at home.
But recent setbacks do not necessarily signal a complete reversal. Japan’s $1.2 trillion Government Pension Investment Fund, the world’s largest, recently hired Ashmore for a new local currency emerging debt mandate, while NEST, the UK government’s workplace pension scheme, last month announced a search for an emerging debt fund manager.
Fund managers also argue that emerging markets comprise a tiny part of institutional allocations — in the case of global pension funds it tends to be well below 5 percent.
Also, unlike most mutual funds they are not usually tied to benchmark indexes — JPMorgan estimates that dedicated investors own only a third of the total $600 billion foreign holdings of EM local debt, while non-dedicated, so-called “crossover” investors hold another 20 percent.
That would leave at least some part of the remaining 45 percent in the hands of institutional or individual investors, JPM said. But for these giant institutions, such amounts are not huge.
“They know that if they have accumulated a significant sized position they can’t exit in a couple of days, and often the EM allocation is a relatively small part of their portfolio so why not hang on to it?,” said Steve Cook, co-head of emerging markets fixed income at Pinebridge Investments.
“It is the retail guys who invested their $20,000 nest egg and follow headlines who tend to sell.”