A cyclical reordering is happening in emerging markets, with Latin America (ex-Brazil) and Eastern Europe overtaking Asia in investor interest and portfolio inflow, say market specialists.
They also argue the dynamics of emerging markets are set to change dramatically, with institutional investors acquiring knowledge on investing in EM at an unprecedented pace.
“There used to be a clear pecking order: Asia had the highest growth, the highest portfolio inflows and the strongest FX appreciation, with LatAm in second place and Eastern Europe in third,” says Imran Ahmad, emerging market strategist for RBS based in London.
“Now we are seeing a reordering of that pecking order. With high oil prices everyone is worried about Asia, with the exception of Malaysia, and the growth story has been mixed in the context of slower Chinese growth. There has been a favouring of Latin America excluding Brazil. A lot of people are thinking about this because they are overweight Asia.”
Denis Girault, co-head of emerging market debt for UBP Asset Management in Zurich, agrees. The firm manages $1.2 billion via four Ucits funds listed in Luxembourg as well as separate mandates.
“For me Asia is a selective bet,” he says. “If I look versus my benchmark I will be underweight Asia. I am more overweight today in Latin America. Many people are heavily invested in Asia versus other regions, but it is a very volatile and unpredictable market.”
Data from fund research firm Strategic Insight backs this up. Asia saw a net portfolio outflow of $12.1 billion in the first quarter this year, compared to inflows of $48.2 billion for Latin America – a $60 billion differential.
Broken down, Asia saw inflows into bonds ($6.7 billion) and real estate ($1.5 billion) in the first three months, but heavy outflows in particular from equities (-$18 billion).
For Latin America, inflows into bonds ($20 billion) and money markets ($15 billion) represented 74% of total inflow for the quarter.
Girault suggests the choices for investing in corporate debt are far more limited in Asia than in LatAm, perhaps because of the greater number of US dollar investors in Latin America.
By this he is not referring to volume, rather sector concentration. He notes that corporate debt is largely issued by banks in India, by mining firms in Indonesia, by real estate firms in China and by banks and utilities in Korea. "Beyond these sector clusters, the liquidity is thin," he suggests.
Volume data show 2,239 EM corporate bonds valued at $468 billion were issued in 2011. Of these, Asia (ex-Japan) accounted for 85% of volume (1,907 issues) and 73% in value ($342 billion). Latin America accounted for 8.8% in volume (198 issues) and 16% in value ($75.1 billion).
The figures are similar year-to-date, with Asia (ex-Japan) 86% in volume terms and 73.5% in value, next to LatAm’s 8.7% and 16.5%, respectively.
Girault and Ahmad agree that institutional investors are increasingly turning their attention to emerging markets, spurred by the burgeoning US deficit and sovereign crisis in Europe.
“We are seeing a shift in mindset among institutional investors thinking they need to invest in emerging markets,” says Girault. “That should have positive implications for the asset class. If you have more players, then liquidity will improve. The dynamic could shift significantly in the near future.”
He confirms the most important factor for emerging markets is whether they can satisfy investor demand. But he points to the Solvency II Directive in Europe, which requires insurance firms to allocate not based on where a company is located, but on credit ratings.
“If it is rated BBB, whether it is based in Brazil or Germany, it will require the same amount of capital,” Girault says. “Institutional investors need to think differently and reconsider if some of their investment guidelines make sense today.”
In terms of the liquidity, a total of $881 billion in EM bonds were issued last year, 15% of global DCM volume ($5.8 trillion). That percentage has risen to 16.8% to date this year, finds Dealogic.
Girault sees a big shift among institutional investors towards investment grade corporate credit, given they can get higher yields on some sovereigns in Europe than in emerging markets.
Ahmad, who focuses on credit, rates and foreign exchange, notes investor interest has been increasing in Mexico this year as well as smaller LatAm credits.
On the institutional side he believes China is leading the way, partly out of necessity as it seeks to diversify its disproportionate $3.3 trillion in foreign exchange reserves.
One example is Investment Corporation of the People’s Republic of China (ICPRC), an offshoot of the State Administration of Foreign Exchange. It was established in Singapore and is dedicated to investing in emerging markets.
“Historically Asian nations have piled everything into US Treasuries, now they are keen to diversify,” says Ahmad. “But China has the biggest problem with foreign exchange reserves and it is being the most aggressive at dealing with it. Now you are seeing a copycat culture.”
He says he used to spend 80% of his time talking to hedge funds, but now that is taken talking to institutional investors. “They are acquiring knowledge on emerging markets at a pace which is unprecedented,” he confirms.