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Emerging Market Bond Fund Flows Signal Shift

Money is continuing to pour into emerging market bond funds, subduing the cost of borrowing for developing countries and underlining the shift in economic power away from the western heavyweights of the financial system.

Sovereign Funds
Sovereign Funds

Eight consecutive weeks of net inflows have taken the total invested in these funds this year to $7.9 billion, according to EPFR, the fund data provider.

This has reduced the yield on emerging market dollar-denominated sovereign and corporate debt to 5.48 percent on average, from 6.14 percent a year ago, at a time when aggregate global yields have edged up, according to calculations by Barclays Capital for the Financial Times.

Indonesia’s fresh $2.5 billion bond, for example, yields 4.7 percent, less than similar maturity euro-denominated debt of Italy and Spain.

Brazilian and Mexican government bonds are trading on similar or lower yields than equivalent Belgian and South Korean sovereign debt issues.

Some emerging market countries are now judged to be less risky borrowers than several western European countries.

The credit default swap index for 15 major emerging market countries has fallen by a third to 206, while the iTraxx SovX index for western European CDS has climbed to almost 190.

“Emerging market debt is no longer a niche,” Simon Lue-Fong, head of emerging market debt at Pictet, the asset manager, said. “It’s losing its risk premium as the developed world has shot itself in the foot.

“Fundamentally, emerging markets are just less leveraged, and thus more able to repay their loans.”

Local currency denominated bonds have proved particularly attractive as fund managers have sought additional returns through the appreciation of emerging market currencies.

Robust inflows into emerging market bonds stand in contrast to nervousness over potentially overheating equity markets in developing countries, and the debt crisis in western Europe’s periphery.

Investors have pulled $12.9 billion out of European bond funds this year, and more than $7 billion was withdrawn from global equity funds last week, of which $1.6 billion came from emerging market equity funds, according to EPFR.

This selling has pushed MSCI’s benchmark Emerging Markets index down 1 percent so far this year, while bonds sold by governments and companies in developing countries have largely held firm.

Analysts have voiced concern over the scale of the inflows into emerging markets. Equity markets have attracted the most attention, but some say borrowing costs are being pushed too low given the risks involved.

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