Emerging markets are in favour, with fund flows into portfolios reaching their highest level for almost a year in the first week of January, according to the Institute of International Finance (IIF).
“Total EM portfolio inflows since the start of the year amounted to some $7bn— about $3.6bn into EM bonds and $3.3bn into EM stocks. However, the recent upswing in flows has not been broad-based. While Indonesia, Thailand and Korea have all seen solid positive inflows, foreign appetite for Philippines, Hungary and South Africa has been lacklustre. We continue to expect a more discriminating approach by EM investors during 2018,” IIF said in a bulletin.
EM investment was gathering momentum in 2017 with non-resident portfolio inflows into EMs of $9.4bn in December and $235bn for the year, well up on the $152bn invested in 2016.
And the EM funds, especially the ETFs, easily outperformed the more traditional indices in 2017. The MSCI EM index beat both the MSCI EAFE and MSCI USA indices, retuning 34.35% over 2017, vs 21.78% and 19.5% respectively.
That is probably good news for Russian stocks, but it may take a while for the EM enthusiasm to feed through. As Russia suffers from a “Russia discount” in addition to the generic EM discount, thanks to its appalling investment image and fraught geopolitics, it is usually last in line for portfolio allocations when EM markets come back into fashion.
And equity investment into Russia is very much fad based. Asbne recently reported that investors are becoming more interested in Russian stocks as it sets off on its fifth super cycle, simply as they are so cheap compared to their EM peers and at a corporate level some companies are seeing strong earnings growth, while the Russian dividend yield remains the highest in the world.
In 2017 the lion’s share of investment into EM was into fixed income, which accounted for $170bn or just under three quarters of all investment into EMs, and that was almost double the $99bn invested into to EM debt a year earlier.
China is still the investment destination of choice however, with just under 80% of all EM investment, or $185bn, into the other EM markets in what was the best year for EM investment since 2014 when the US Federal Reserve bank ended its quantitative easing programme, according to IIF.
Debt has been favoured as EM still pay high yields versus the near zero-yield available in the developed markets and several exotic issuers tapped the market with billion-dollar issues, including Ukraine, Belarus and Turkmenistan’s debut issue.
“Underscored by the 3-year high in portfolio flows, emerging markets got some help from a weaker USD and gradual, well-communicated Fed moves, allowing EMs to issue record amounts of FX-denominated debt,” IIF said.
While conditions remain benign for these exotic issuers – Ukraine has already said it is planning more Eurobond issues in 2018 – as the Fed is expected to raise interest rates at least once this year, the EM issuers are likely to face some stronger headwinds with bond issues in 2018.
Russia in particular may see a rout on its bond market as the US is due to decide on the imposition of fresh financial sanctions in February that could include a ban on international investors buying the sovereign treasury bonds, the OFZ, that the Ministry of Finance uses to finance the federal budget deficit. More than RUB1 trillion ($17.5bn) of OFZs are scheduled to be issued in 2018, according to the new budget, and they have been extremely popular with foreign investors as they pay good returns but are backed by Russia’s robust macroeconomic position, large currency reserves and low debt.
This danger is already pushing investors into equity where the returns can be higher and the best names that focus on catering to domestic demand are to an extent insulated from the geopolitical risks.
Russia also benefits from its return to growth and especially a recovery in commodity prices as the global economy returns to above average growth; Russia’s economy is more highly correlated with commodity prices (and especially oil prices) than most.
Looking at the net capital inflows last year, Russia did well with inflows tripling to $3.7bn in the first 11 months of the year against the $1bn it attracted in the same period a year earlier. This includes a $11.3bn outflow in the first quarter of 2017.
Ukraine also attracted inflows totalling $5.8bn in the same period, although preliminary evidence suggests this is mostly remittances of workers elsewhere sending money home. Due to the boom in CEE countries there are now actively recruiting Ukrainian workers to the point where businesses in Kyiv say their biggest challenge this year will be to retain staff. In 2017 the state statistics office estimates overseas worker sent back $5bn from abroad, which has become a major source of hard currency revenue for the country.
But from the countries covered by IIF’s basket, the really outstanding member was Czechia that saw $45.8bn of inflows in the 11 months of 2017, second only to India in the EM universe.