No news is good news. “Investors did not panic” at the rising threat of a Greek default and continued to put money into EM bond funds over the past week, Demetrios Efstathiou of RBS wrote in a note to clients on Friday.

But data for the week to Wednesday from EPFR, the fund flow watcher, show investors did take a whopping $16.7bn out of super-conservative money market funds. As Luis Costa at Citi told beyondbrics, such behaviour is erratic – and worrisome.

First the good news. EM bond funds attracted $559m in the week according to EPFR, of which $277m went to local currency funds and $244m to blend currency funds, with just $38m going into hard currency EM bond funds. Accumulated inflows to EM bonds over the past four weeks were $1.4bn.

This suggests that, even in today’s highly stressed markets, investors believe EM bonds are a good bet.

It could also mean, of course, they just think they are less of a bad bet than equities, where the exodus continued. Investors took $1.3bn from EM equity funds in the week and $5bn over the past four weeks.

But if the EM bond flows suggest investors are looking for safe havens, that’s not a view supported by the outflows from money market funds. Those funds have attracted huge inflows recently: $11.5bn last week and nearly $50bn, for example, in the week to August 10. So why this week’s outlflows?

“Money markets have been extremely erratic,” Costa at Citi told beyondbrics. “If you believed this was a run for the hills situation you would put your money back into money markets and not care about the level of return. You wouldn’t be playing local currency EM. So the message is divergent, and that divergence is worrisome.”

Support for EM bonds, he says, could be explained by the arrival of new types of investor playing across different asset classes. And the otherwise erratic behaviour of markets doesn’t mean that we are about to see the kind of forced redemptions that have happened at other recent times of crisis – yet.

The fact that equities are performing so badly suggests bond investors will stay put longer. “We haven’t hit the pain threshold yet” at which forced redemptions would kick in, Costa says.

In a note to clients on Friday, Costa presents a chart showing how outflows from EM bond funds combined with falling net asset values in major EMs to deliver very negative performance. They were: the collapse of Lehman brothers in September 2008; the banking sector worries of early 2009; the first Greek-inspired major sell-off in April/May 2010; and the Irish rescue package of October 2010.

Here’s the chart (click to enlarge). Those of a pessimistic disposition may spot something similar beginning to happen at its right hand edge.

Related reading:
EPFR file, beyondbrics

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