Measuring flows to EM fixed income

There has been an increased focus on flows into emerging market funds turning positive after a challenging two years, with questions asked on how sustainable the drivers could be. In this blog we provide a primer on our understanding of the data that underpins much of these discussions. 

Most broker publications on flows into emerging markets funds rely on a database maintained by Emerging Portfolio Fund Research (EPFR). The EPFR dataset has a number of useful facets and as such is an important research resource for active fixed income investors. However, given its relatively small scale and limited representation, we believe more in-depth analysis is warranted.

The database provides numbers on mutual fund flows into developed and emerging markets across both equity and fixed income. Data is derived from a sample of asset managers that have data sharing agreements with custodians that choose to share their assets under management (AUM) and flows.  In some cases, the data is supplemented by incorporating publicly available exchange-traded fund (ETF) flows which are categorised in three ways: 

• By fund type – whether the fund is dedicated to emerging markets or to developed markets, based on EPFR definitions[1] 
• By investor type – whether flows are retail (including ETF) or institutional, with the differentiation being based on amounts invested rather than the reporting funds own definition[2]
• By domicile – where the funds are based, whether in Asia, Europe, or the US and others

EPFR flows thus only reflect self-reported mutual funds and ETFs; they exclude crossover investors that have been an increasing source of demand for emerging market debt, and segregated mandates within reporting funds. The data also excludes large institutional investors such as sovereign wealth funds, pension funds, hedge funds and banks proprietary trading desks[3]

Highlighting the data’s relatively small footprint, the AUM of the funds reporting flows is under 10% of the market cap of the benchmark in external debt. Even within this, the skew is heavily towards European domiciled funds (c.75%). Meanwhile, ETF flows have become increasingly significant (20%+), reflecting fast growth and the ease and frequency with which the data is available. 

These ETF flows behave slightly differently, generally being less sticky than mutual funds, or strategic/segregated mandates. In emerging market local markets, the AUM of reporting funds is even smaller at just 1% of the index, but here too funds domiciled in Europe tend to dominate. Emerging market equities fare somewhat better - with funds reporting comprising just under 20% of market cap. 

Notwithstanding the above, using this data, most large brokers produce regular publications on fund flows that have now become widely followed as a gauge of risk appetite toward emerging markets. Most will focus on weekly datasets to smooth out daily flow volatility. This weekly data runs Wednesday to Wednesday, with brokers typically releasing reports on Thursday or Friday. The data/analysis reported across these publications is mostly consistent although there can be discrepancies when EPFR flows are supplemented with the institutions own surveys and/or other high frequency data. 

In hard currency funds, a significant part of the variation in the flows reported by various brokers is generally driven by variation in flows to a small number of large ETFs; this is not the case for local or blended funds. In local markets, one source of variation is often from investors breaking out flows to China separately. The latter appears to behave more idiosyncratically – in recent weeks for example, we have seen large inflows by China domiciled investors into Chinese bonds. 

After a protracted period of muted or negative activity, flows to emerging market funds have turned positive in recent months, reflecting how policy and institutional uncertainties in the US may be leading some global investors to diversify into EM assets. While many investors are still under-invested in emerging market debt, this is starting to change. 

However, while flows data is an important gauge of fund flows and relative attractiveness of emerging market assets, caution is warranted in interpretation given how its collected (voluntarily), from who (mostly just mutual funds and ETFs, mostly in Europe) and how its disaggregated. The data excludes some of the most important sources of demand for EM assets such as dedicated and cross over investors. 

 

[1] A dedicated EM bond fund is one with at least two-thirds of its assets in emerging market bonds, while a DM mandate fund has at least two-thirds in developed market bonds

[2] ‘Retail investors’ are defined as investors with less than $100,000 invested; 'institutional investors' as those investing more than $100,000

[3] In addition, it’s important to note that net flows (issuance) always sum to zero. So flow data only tells us is what one specific investor is doing.