Investors will withdraw $50 billion from emerging market bond funds in 2022

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Investors withdrew $50 billion from emerging market bond funds this year in the latest sign of how a sharp monetary policy tightening in developed economies and war in Ukraine sparked a flight from the asset class .

Net outflows from emerging-market fixed-income funds are the largest in at least 17 years, much worse than during an episode of heightened concern about China’s economy in 2015, according to data compiled by JPMorgan.

“It’s been quite dramatic,” said Marco Ruijer, emerging markets portfolio manager at William Blair, adding that the combination of soaring global inflation, central bank monetary policy tightening and the Russia’s invasion of Ukraine has resulted in “a perfect storm” for emerging markets. debt.

The sharp drop in emerging market bonds, which are generally considered riskier than their developed market counterparts, has led to a sharp drop in prices this year. The benchmark dollar-denominated emerging market sovereign bond index, the JPMorgan EMBI Global Diversified, generated total returns of minus 18.6% in 2022, leaving it on course for its worst annual run on record.

Emerging markets were already suffering disproportionately from stretched finances amid the coronavirus pandemic even before this year’s headwinds hit.

The Federal Reserve rate is rising this year, and plans for more on the horizon, are particularly toxic for emerging markets, as they have increased the fixed returns investors can earn by holding ultra-safe US debt, eroding some of the appeal of bonds sold by issuers with weaker credit profiles. Some investors are also worried that tighter US monetary policy and growing economic pressure in other major markets like Germany and Italy have heightened the risks of a broad-based economic slowdown.

“Before the Fed started to increase, the asset class was not doing too well [and then] the market started to turn a bit on fears of a recession, which caused another big sell-off,” Ruijer added.

Column chart of JPMorgan EMBI Global Diversified, year-to-date total returns (%) showing emerging market debt having its worst year on record

The global commodity price shock triggered by Russia’s war in Ukraine has been a boon for some commodity-exporting developing countries. “Much of our universe are commodity exporters, so a lot of those countries have a windfall,” Ruijer said.

However, major energy importers such as Turkey are being hit hard by the rising cost of raw materials such as oil. Since most commodities are denominated in dollars, a weakening of emerging market currencies against the greenback amplifies these cost pressures.

Ruijer added that while opportunities exist, the bleak global economic outlook and the expectation of falling commodity prices due to a recession means investors have been “pushed”.[ing] the sell button.

“These assets tend to be quite positively correlated with the economic cycle,” said Cristian Maggio, head of emerging markets strategy at TD Securities. He added that investors have been “deterred from having broad exposure to emerging markets by the fact that growth prospects are deteriorating day by day.”

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