Global EM fund flows heavily favour Asia

US research highlights the dominance of China and Asia in global mutual fund and ETF flows to emerging markets, revealing a startling imbalance between equity and bond allocations.
Global EM fund flows heavily favour Asia

Asian markets, and China in particular, are the main targets for global mutual fund and ETF portfolios in their allocations to emerging markets, states a new research paper set to be released.

The survey of predominantly US and European mutual funds, which constitute 80% of the $30 trillion global funds industry, also highlights the imbalance between these global funds’ Asia equity and bond investments.

ICI Global, the international arm of the Investment Company Institute, the lobby group for the US mutual funds industry, is set to issue the study this week, putting perspective on global investment flows to emerging markets. AsianInvestor was given a sneak preview.

The researchers said they were shocked by both the size of the Asian equity numbers but also by the low level of Asian bond holdings.

From 2000 to 2013, emerging economies received cumulative gross capital inflows of nearly $10 trillion. Of this, $1.7 trillion came from foreign investors' allocations to stocks and bonds.

The results show that Asia-Pacific markets are drawing 70% of US and EU equity flows, with $900 billion invested in equities since 2000, but only $100 billion in Asian bonds.

“Nonetheless, that’s a trillion dollars from regulated funds alone,” noted Chris Plantier, ICI senior economist, talking to AsianInvestor from the group headquarters in Washington DC.

“The other thing that really stuck out was just how much there is in Chinese equities. We assumed, because of the relatively restricted nature of investment in China, the numbers would not be that great. But we found there has been $290 billion invested by US and European funds, with the vast majority going into H-shares and ADRs [American Depositary Receipts].”

While the global index weightings for China are lagging the true size of China’s market, Plantier said the likelihood was that a lot of this "offshore" exposure would be converted to direct China exchange investment once the market opened up.

“The reason these vehicles are popular for US investors today is they are liquid and traded in US dollars," he explained. "At this point mutual funds are not going to break new ground by investing in A-shares.”

As well as China, ICI Global’s research also shows the portfolio flows to each country in the region. Korea, India, Taiwan and Hong Kong are the other major beneficiaries, with investors showing an absolute preference for equity over bond exposure.

While the research clearly demonstrates the strength and diversity of foreign equity exposure, what was more surprising, said Plantier, was how little was invested in Asian bonds.

“I was shocked by how little investment there is in some countries. India has $130 billion invested in equities but only $9 billion in bonds. Maybe interest rates aren’t very attractive given the inflation background. Still, the contrast is striking.”

Foreign investment in Taiwanese bonds is even more anaemic. Taiwan attracted $107 billion to equity investments over the period, but only $224 million of bond investment from global fund investors.

Plantier said this situation was likely to continue for as long as Asian countries are importing US interest-rate policy and while inflation remained a concern in countries such as India. The level of Asian bond investments had remained static for the past two years, Plantier noted, partly because of the ‘taper tantrum’ and worries about rising interest rates in the US.

The main motivation for this research by ICI Global was to assess the impact of foreign fund flows on emerging markets, following an IMF report suggesting that collective fund flows into emerging markets had a potentially de-stabilising effect on these markets.

“On the contrary,” said Plantier. “Our research shows that fund investments in Asian emerging markets are net positive and represent a stable part of the investor base in these markets.”

“There’s always a concern about whether foreign investors are in it for the long term. Our research shows that in 2013 regulated funds held more than half of the emerging market equities held by foreign investors and 30% of EM bonds.

"But on average, they accounted for less than 15% of the variance of foreign portfolio capital flows to emerging markets from 2005 to 2013.”

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