Caution May be Creeping in to Emerging Markets –IIF

Investor caution may be starting to creep into emerging markets following a blistering rally so far this year, the Institute of International Finance (IIF) said on Thursday.

A combination of increasing global growth, low interest rates and a weak dollar have fuelled the surge in emerging economy currencies and assets, but the capital flow tracker pointed to possible signs of a pause, Reuters reports.

Referencing EPFR data, the IIF said the first cumulative withdrawal of cash from emerging market funds since January occurred last week. The outflow was mainly stocks-driven though EM bond investors had also turned more neutral.

“While flows to emerging markets have been resilient over the past few weeks, our investor sentiment metrics suggest a more cautious tone,” the IFF report said.

“Our EM risk appetite metric suggests that investors continue to take on credit risk in search for yield, but have turned slightly negative on EM currency risk despite recent U.S. dollar weakness.”

Bank of America Merrill Lynch painted a similar picture in a report last week. It said emerging market stocks suffered their first outflows in 22 weeks, losing $1.6 billion as investors eased away from riskier assets.

MSCI’s benchmark emerging equities index saw its biggest weekly fall since December, as nerves around U.S. and North Korea tensions hit Asian markets such as South Korea .

Emerging market debt funds suffered their first outflows in 29 weeks, BAML added -- albeit a modest $100 million -- while $2.3 billion was pulled from high-yield bond funds, the biggest outflows in almost six months.

Investors are not expected to jump to definitive conclusions however.

Trading in August and early September tends to be thin due to the summer holiday exodus in U.S. and European markets in particular. But it means the flows will be scrutinised as volumes start to pick up again.

The EPFR data shows that international investors have piled around $122 billion into emerging market-focused funds this year. Euro area investors have provided $77.5 billion of that, $62.5 billion of which has gone into EM bond funds.

That euro zone dominance has been maintained in recent weeks by a more dovish tone from the European Central Bank.

In contrast, with EM corporate profitability approaching robust 2010 levels, U.S. investors have dominated equity fund flows. Since mid-July, U.S. flows to EM equities reached nearly $5 billion, over 60 percent of the total inflow, the IIF said.

All the countries in the IIF's sample group with the exception of Colombia have seen positive bond fund inflows since mid-July.

Among EM equity funds, flows into Colombia were particularly strong as where those into Korea and Mexico, while Russia and Saudi Arabia saw net outflows.