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October 3, 2016

Monday Morning Memo: Will E.M. Funds be on Investors’ Christmas Lists?

by Jake Moeller.

There is something strangely reassuring about seeing festive decorations being displayed in a large London department store only a few days after the U.K.’s hottest September day in 60 years. With one final flourish, summer is gone. Light trading volumes and asset allocation indecision should now be replaced with conviction and some assertion on the part of funds investors, heading into the final quarter of the year.

June and July European fund-flow data revealed considerable “Brexit”-induced risk aversion, with investors taking flight from broad-based pan-European and U.K. equities funds and flocking into Dublin-based money market vehicles. August European data from Lipper revealed that, although many investors are continuing to keep their powder dry (USD-, GBP-, and EUR-denominated money market funds collected over €14 billion for August), others appeared to have decided where they want to be by year’s end.

Other than money market fund movements, the best selling sector for Europe for August was Global Emerging Market Equity funds, which collected some €4.6 billion of net sales for the month. It was followed by Bond Global (+€3.5 billion), Bond Emerging Markets in Hard Currencies (+€2.9 billion), and Bond Emerging Markets in Local Currencies (+€2.2 billion).

Exhibit 1. Estimated Net Sales by Asset Type, August 2016 (Euro Billions)

Source: Thomson Reuters

It appears, then, that after five years in the wilderness, emerging markets (EM) might finally be showing a return to favour. In Europe Brexit has confirmed a “lower for longer” interest rate environment, providing a natural feeder into riskier yield- bearing assets. The U.S. too seems to be unable to provide a guaranteed upward trajectory in rates, despite expectations.

There is also now a confluence of strong performance to encourage investors. Last summer’s memory of the China “wobble” and its accompanying volatility feels distant; for 2016 year to date the average return of funds in the IA Global Emerging Markets equity sector is 29.0% (to August 31, 2016, in GBP), with the IA Global Emerging Markets bond sector average returning 26.0% and China/Greater China 18.7% over the same period. That makes the return of the IA Sterling High Yield sector of 9.3% on average look somewhat Spartan by comparison.

Chasing returns is an investment strategy likely to disappoint, and chasing the hot money into EM may be similarly inadvisable. However, it is likely that—as we head toward the end of the year—there will be further offloading of cash. Discretionary fund managers in the U.K. and Europe who are still cash heavy will not be able to justify significant holdings to their clients come Christmas. And where do you allocate when yield and dividends in developed markets are at a considerable premium?

Exhibit 2. Ten Top Sectors, August 2016 (Euro Billions)

Source: Thomson Reuters

In a recent podcast with Thomson Reuters, Martin Gilbert—the CEO of Aberdeen Asset Management — noted “sentiment (on EM) has improved considerably.” This coincided with a sixth monthly increase in Aberdeen’s share price of 15% (to September 19, 2016) and, as Gilbert noted, a material reduction in short positions on Aberdeen’s stock.

I’m not one for reading runes, but I will certainly be keeping an eye on EM fund flows in the final quarter. As the summer revealed, developed markets carry political risk, rates are staying low, and recent risk aversion has seen large and perhaps unsustainable inflows into cash.

Summer is over, and now decisions have to be made in time for Christmas.

A version of this article first appeared in FT Adviser Blog.

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