Emerging markets (EM) have started the year with a bang, as significant inflows have moved into both equities and bonds. After a terrible 2022, the fresh slate for taking risk coupled with the reopening of China has reinvigorated demand for risk assets, including EM.
For fixed income, the recovery in performance dates back to Q4 2022, with the Bloomberg EM Local Liquid Index returning 8.8% during the quarter.1 At that stage, investors still seemed cautious on EM debt and we saw little evidence that this better performance was backed by meaningful inflows. This can be seen in the investor flows section of the Bond Compass, where Q4 was marked by a distinct preference for lower-risk strategies (investment grade credit favoured versus high yield) and developed market bonds seeing inflows in their 90th percentile while EM debt remained unloved.
While there was undeniably caution around EM assets, the fixed income flows data from the Institute of International Finance suggests a more nuanced story was at play during 2022. The chart below shows the investor flows split into those going into China debt and those into the broader EM complex (ex China). It is clear that the invasion of Ukraine sparked a massive outflow from Chinese debt funds, with appetite failing to stabilise until Q4. Conversely, non-China debt seems to have benefitted from the China exodus with what looks like big switches out of China bonds into other markets in February and March.
The second half of the year saw Chinese bonds continue to suffer outflows as they became less appealing as a source of yield2 relative to either US Treasuries or other EM debt. So EM ex China strategies continued to enjoy inflows in H2, taking non-China debt flows to $108 billion for the year.
Emerging Market Debt Investor Flows in 2022
The net flows position for all EM debt totalled $37 billion for 2022. The flows analysis illustrates that, outside of China, sentiment in EM was not as downbeat as perhaps some of the headline flows numbers suggest. However, there is little ambiguity to the flows data that has been seen so far in 2023, with a wave of money being allocated to EM strategies. There has been a lot of focus on equity inflows but European fixed income investors have purchased of $950 million of EM debt ETFs during the first 26 days of January.
As we highlighted in the Bond Compass, EM local currency debt in particular has several relatively attractive attributes for bond investors.
So EM debt has already delivered a strong performance but we believe that there is more to come, with flows hinting that it is one of the favoured strategies for 2023.
1 Source: Bloomberg Finance L.P., as of 31 December 2022. Past performance is not a reliable indicator of future performance. Index returns are unmanaged and do not reflect the deduction of any fees or expenses. Index returns reflect all items of income, gain and loss and the reinvestment of dividends and other income as applicable.
2 The 10-year China Treasury yield remained in the 2.60-2.95% range for the whole of 2022 while US Treasuries rose from 1.5% at the end of 2021 to above 4% in October 2022. Source: Bloomberg Finance L.P., as of 31 December 2022.
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