INVESTOR BEHAVIOUR: CONCEPTS
In an ideal world, we would know which investors held which assets, and how that changed through time. We would know how investors are positioned: their actual holdings relative to some sort of neutral or baseline.
In the real world we lack all this information and have to work our way towards this, and in this section we explain some of the things that we use to do that. They tend to be quantity data, meaning they can have a stock – a quantity at a point in time – or a flow – a rate of change of a quantity through time. The key point about them is that they are, broadly speaking, available. They are there and can be used.
WHAT ARE FUND FLOWS?
Fund Flows reflect the net of all cash inflows and outflows from a mutual fund or ETF. This means that fund flows do not consider the change of performance from the fund or the assets from the fund. However, a positive fund flow can be interpreted as excess cash for fund managers to invest, which would potentially increase the purchase of assets from the fund.
Fund Flows=fund cash inflows – fund cash outflows
Example: A UK-domiciled investor wants an exposure to emerging markets sovereign debt but wants to diversify by investing in different EM sovereign debt. After some research, he decides to invest £10,000 in a UK-domiciled mutual fund focused on emerging sovereign debt. As a result, the £10,000 would become a fund cash inflow and, if everything stays the same, would reflect a positive fund flow for the mutual fund.
WHAT ARE THE FLOW OF FUNDS ACCOUNTS?
Flow of funds accounts are a system of interrelated balance sheets for a nation, calculated periodically. It is an extensive and reliable source to understand the financial status from specific sectors of the economy such as the government, households, businesses, and financial institutions. For example, we can quantify the level of liquidity risk of the pension fund sector by analyzing its assets and liabilities data provided by the flow of funds. Normally, the government of a particular country publishes the flow of funds quarterly. In the report, there are two types of balance sheets:
WHAT ARE PORTFOLIO FLOWS?
Portfolio flows are cross-border transactions in financial assets: flows of money and assets across borders. If a UK investor buys bonds or equities from a US holder, that’s a portfolio flows.
Portfolio assets are things like bonds and equities. Economists use the phrase portfolio flows specifically to mean the cross-border flows, and these they record in the balance of payments.
WHAT ARE CAPITAL FLOWS?
Capital flows: this term covers all the cross-border transactions, not only the portfolio flows, but foreign direct investment (e.g. when a controlling interest, not just a share in something, is traded) and other investment flows – the (foreign) capital which flows into banks and other financial institutions.
To read a technical document from the IMF on tracking capital flows, click here
POSITIONING AND LIQUIDITY
Liquidity: The term liquidity is used to indicate how fast can an investor buy or sell a particular asset. The higher the liquidity, the better it is for investors as they have the flexibility to move in or out of an asset depending on the status of economic factors, asset-specific factors, or investor’s sentiment. Liquidity is particularly important in periods of recessions and market corrections since asset prices usually decline significantly in a short period of time. Investors who have low liquidity assets in these periods may be unable to sell the assets in time, resulting in great losses in their portfolio. However, some investors may become attracted to illiquid assets if they offer higher returns than liquid assets.
WHAT ARE FUND ALLOCATIONS?
Fund allocations: the asset allocations of mutual funds and ETFs at a point in time are a form of positioning data. If the weighted average allocation of a large group of foreign-domiciled asset management companies’ dedicated emerging market debt funds to South African government debt is below the weight of South Africa in the benchmark index those funds follow, then we say directly that that group is underweight. It might be that, if we see large bond portfolio outflows from South Africa, that that group is reducing allocations to South Africa, but there might be another explanation, for example selling by funds not dedicated to emerging market debt. Positioning data speaks more directly than flow data here.
WHAT IS MARKET STRUCTURE?
Market structure: the composition of the holders of portfolio securities at a point in time are a form of positioning data. Different holders have different motivations and different constraints and these give rise to different behaviours. You can arrive at positioning by knowing about the different investors in a market (market structure) and how they are positioned (e.g. through their asset allocations).
The behaviour of foreign investors can a big impact on the price of bonds issued by emerging market sovereigns. If foreigners suddenly start to demand more bonds from Nigeria, Colombia, Romania, Sri Lanka, Pakistan, Egypt or the Ukraine, for example, prices can react strongly. This is not so much the case in larger EM bond markets like Brazil or Mexico.
The behavior of local investors can have a big impact on asset prices. Some markets have large local institutional investors bases, e.g. South Africa or Brazil. In these countries, local investors work as buffers of selloffs by foreign investors. On the contrary, markets, which are highly dependent on foreign investors, have a great risk of significant asset prices corrections due to capital outflows.
INVESTOR BEHAVIOUR: IN PRACTICE
In practice there are some issues to do with using fund flow, fund allocation, portfolio flow and other datasets. The data can be biased, or incomplete, or not categorised properly, or have other problems. There is a choice of data providers.
Trounceflow makes fund flow data.
These explain the detailed allocations to such things as countries, currencies, sectors, industries, credit rating types, as well as give the levels of cash allocations and the weighted average yield and duration of the fund.
They are published with a lag. In general, sufficient are published 2-3 weeks after the end of the month, and we publish our average allocations data on the 18th of the following month, i.e. on the 18th August we will publish allocations for 31st July.
USING AVERAGE FUND ALLOCATIONS
We calculate average allocations as the average of the sample of available data.
For example, if we find allocations to the Mexican Peso on 35 fund factsheets, then we report the average allocation as the mean of that sample.
The allocations themselves are reported as absolute percentages (for example 9.9% or 8.4%). Average allocations can be calculated for allocations to countries, currencies, duration, yield, cash and credit ratings.
Different definitions of the variables are used to calculate the averages (e.g. Average yield includes YTM, average yields, etc..). Credit ratings average allocations do not sum to 100% as funds often report their allocations in bands, whereas we calculate averages across specific credit ratings.
BIASES WHEN USING AVERAGE FUND ALLOCATIONS
Since many funds only report their top 10 country allocations on their factsheets, this produces allocation data which has an upward selection bias as we are more likely to include a country’s allocation if it has a higher allocation. This is more pronounced for countries that have a lower weight in the benchmark.
We also calculate average allocations that assume that funds not reporting their allocation for a country have a zero allocation or the same allocation as the benchmark. The closer these values are together, the more confidence we have in the allocation.
PRICE-BASED MEASURES (FUND BETAS)
Inferring positioning in risk factors from performance:
It is possible to “back out” or make inferences about positioning using price data (total return data). The performance of a fund – the total return over 1 (3, 5 and 10) year(s) – can be compared to the performance of the benchmark index.
If the fund has outperformed the index during a period when riskier assets outperformed less risky assets, then we can infer that the fund’s positioning was “risk-on”.
The fund must have been overweight the bonds which increased in value more than average – the riskier bonds – and underweight the bonds which increased in value less than average – the less risky bonds.
In our decomposition of investors of emerging market local currency government bonds, we made a major distinction between dedicated and undedicated investors, defining dedicated investors as those that are benchmarked to JPMorgan GBI-EM (or EMBI in the hard currency universe).
WGBI INCLUSION/EXCLUSION EFFECT ON FLOWS
The World Government Bond Index (WGBI) measures the performance of fixed-rate, local currency, investment-grade sovereign bonds. Composed by more than 23 countries, the WGBI has minimum requirements to allow sovereign bonds into the index:
WGBI serves as an important benchmark for passive and active global fund managers. In the case of passive funds, they directly adjust their portfolio by purchasing or selling bonds to replicate the portfolio allocation of the WGBI. Similarly, active funds are constantly compared to the WGBI as a benchmark and are expected to overperform. If an active fund performs equally or lower than the WGBI benchmark, then investors from the fund may decide to remove their capital from the active fund and invest in a passive fund with lower commission. As a result, many active fund managers control the risk of underperforming by having some degree of similarity to the WGBI portfolio allocation. The significant influence of the WGBI on active and passive managers causes massive correlation in capital inflows and outflows of emerging markets. This is known as “the index effect” – the phenomenon of abnormal trading volumes that are a consequence of either:
When a new sovereign bond is included in the WGBI, benchmark-driven funds adjust their portfolio by using cash or selling assets to purchase the new sovereign bond. In the same manner, an increase of a sovereign bond’s weight in the WGBI causes benchmark-driven funds to sell other assets and purchase more of the sovereign bond. The magnitude of the “index effect” varies between markets. The more benchmark-driven funds in a market, the bigger the effect on asset prices.
|Funds with Active Management – WGBI as Benchmark||AUM ($ bn)|
|Templeton Global Bond Fund/United States||26.89|
|DFA Five-Year Global Fixed Income Portfolio||15.20|
|DFA Two-Year Global Fixed Income Portfolio||5.80|
|Hartford World Bond Fund||5.50|
|Legg Mason BW Global Opportunities Bond Fund||2.95|
|DoubleLine Global Bond Fund||1.15|
|HSBC Global Funds ICAV – Global Government Bond Index Fund||1.05|
|SA Global Fixed Income Fund||0.80|
|AST Templeton Global Bond Portfolio||0.33|
|Funds with Passive Management – WGBI as Benchmark||AUM ($ bn)|
|UBS CH Institutional Fund – Global Bonds Passive II hedged CHF||2.98|
|iShares Overseas Government Bond Index Fund (UK)||2.55|
|Xtrackers II Global Government Bond UCITS ETF||2.42|
|iShares Global Government Bond Index Fund||0.45|
|Next Funds International Bond Ftse World Government Bond Index ex Japan Unhedged ETF||0.05|
|23 Countries in the WGBI|
|Provider||Fund allocations||Fund flows
|JPMorgan Research||Survey data||EPFR|
|Bank of America||Monthly|
|Other Sell-side Research||EPFR|
|BIS Locational Banking Statistics|
|BIS Consolidated Banking Statistics|
|Fund Flows||Portfolio Flows||Capital Flows||Public Debt||External Debt||Market Structure||Dedicated||Undedicated|
|Bank of America|
|Other Sell-side Research||EPFR|
|BIS Locational Banking Statistics|
|BIS Consolidated Banking Statistics|
FLOWS & POSITIONS DATA VENDORS
EPFR Global is a brand owned by Informa PLC, a FTSE-100 listed UK company, as part of their Informa Intelligence Division. Informa acquired EPFR Global in 2010. EPFR provides fund flow data with a one-day lag and fund allocation data with a 23-day lag.
Founded in 1973 as Lipper Analytical Services, it was acquired by Reuters in 1998. Following the merger of Thomson Financial and Reuters in April 2008, Lipper became part of Thomson Reuters.
The Institute for International Finance (IIF) is the global association of the financial industry, with close to 500 members from 70 countries. IIF members include most of the world’s largest commercial banks and investment banks, along with a number of insurance companies and investment management firms. Associate members include multinational corporations, trading companies, export credit agencies, and multilateral agencies.
Some hedge funds are members; many are not.
It has a research department that not only provides briefings but which manages macroeconomic and financial databases, including capital flows and debt. These are only accessible for members.
The International Monetary Fund hosts a number of databases. One, the Balance of Payments (BOP), contains balance of payments and international investment position data of individual countries.
Push Factors and Capital Flows to Emerging Markets
Author/Editor: Cerruti, E., S. Claessens, and D. Puy (2015)
Series: IMF Working Paper 5/127, Washington, DC
EMs need to closely monitor their lenders and investors to assess their inflow exposures to global push factors…EMs with deep financial markets and a high exposure to “fickle investors,” rather than those with more sound institutional or macroeconomic fundamentals, should expect to receive (or lose) external funding when financial conditions in advanced countries improve (or deteriorate)…borrowers’ fundamentals do matter…countries with macroeconomic or institutional deficiencies tend to receive less capital inflows…but the traditional “push factor” debate may have over-stated the importance of fundamentals in shaping sensitivities to external shocks at the expense of other important determinants…authorities in EMs should put efforts into collecting information about their foreign investor base and the role of large funds (or asset management companies) in it.
Multi-Sector Bond Funds Risks in Emerging Markets
Author/Editor: Fabio Cortes, Luca Sanfilippo. (2020)
Series: IMF Working Paper 20/152 , Washington, DC.
“Emerging economies in the post-crisis period increasingly saw portfolio debt inflows from a type of large international investment fund: Multi-Sector Bond Funds (MSBFs). These investors have lacked adequate representation in the literature. This paper constructs a new detailed database from micro-level MSBF emerging market (EM) holdings from 2009:Q4–2018:Q2. Exploiting this data, the paper assesses the risks they pose to the financial stability of specific emerging bond markets. The data shows that MSBFs are highly concentrated–both in their positions and their decision-making. The empirical results further suggest that MSBFs exhibit opportunistic behavior (and more so than other investment funds). In periods of high risk aversion, large MSBF portfolio reallocations out of EMs can be associated with underperformance of the same markets, signaling the importance of monitoring their footprint and better understanding their asset allocation decisions.”
Differential Treatment in the Bond Market
Author/Editor: Converse, Nathan, and Enrico Mallucci (2019)
Series: International Finance Discussion Papers 1261.
“The results are supportive of models of sovereign default that assign a nontrivial role to the preferences of international creditors.”
Capital Flow Data
The Role of Benchmark-Driven Investors
Author/Editor: Serkan Arslanalp and Takahiro Tsuda (2015)
Series: Working Paper No. 15/263
“Portfolio flows to emerging markets (EMs) tend to be correlated. A possible explanation is the role global benchmarks play in allocating capital internationally, the so-called “benchmark effect.” This paper finds that benchmark-driven investors indeed play a large role in a key segment of the market—the EM local currency government bond market—, accounting for more than one third of total foreign holdings as of end-2014. We find that the prominence of these investors declined somewhat after the May 2013 taper tantrum, but remain high. This distinction is important in understanding the drivers of EM capital flows and their sensitivity to different types of shocks. In particular, a high share of benchmark-driven investors may result in capital flows that are more sensitive to global shocks and less sensitive to country factors.”
Drivers of Capital Flows to Emerging Markets
Author/Editor: Robin Koepke
This paper reviews the rapidly growing empirical literature on the drivers of capital flows to emerging markets. The empirical evidence is structured based on the recognition that the drivers of capital flows vary over time and across different types of capital flows. The drivers are classified using the traditional “push vs. pull” framework, which is augmented by a distinction between cyclical and structural factors. Push factors are found to matter most for portfolio flows, somewhat less for banking flows, and least for FDI. Pull factors matter for all three components, but most for banking flows. A historical perspective suggests that the recent literature may have overemphasized the importance of cyclical factors at the expense of longer-term structural trends.
Update on Benchmark-Driven Investors
Author/Editor: Serkan Arslanalp, Dimitris Drakopoulos, Rohit Goel, and Robin Koepke
First, we provide an overview of how key EM bond benchmark indices are constructed, how they affect the behavior of investment funds, and what are the likely implications for capital flows dynamics. Second, we provide up-to-date estimates of the size of benchmark-driven investments in local EM bond markets, estimated at around $300 billion as of end 2019 before the COVID-19 shock in early 2020 (Figure 2). Third, we provide empirical results demonstrating the heightened sensitivity of benchmark-driven investments to external factors, which leads to an elevated correlation of such flows across countries.
Emerging markets and cross-border financial plumbing
Author/Editor: Gongpil Choi, Federico Ortega and Manmohan Singh
To overcome constraints for collateral pledgeability, EMs need extensive rewiring of their present plumbing to connect existing institutions to allow movement across the border without incurring serious prudential implications for financial stability.
This requires EMs to formulate new governance, including a tiered collateral framework to expedite cross-border financial plumbing in collaboration with the ICSD and CSDs; or induce global banks to substitute their excess reserves for higher returns (via haircuts on EM securities), or create central banks’ cross-border collateral pool.
The recent trend is very positive and suggests that EMs are “waking up” to become part of the global plumbing—although in small bilateral steps
INVESTOR BEHAVIOUR: BASIC TRAINING
WHAT IS A MUTUAL FUND?
WHAT IS AN ETF?
Q. What is an ETF?
A. An exchange-traded fund (ETF) is a pooled investment vehicle with shares that trade intraday on stock exchanges at a market-determined price.
Q. So ETF’s are like shares?
A. Yes, in that you may buy or sell them through a broker just like you would the sharesBut ETF’s are pooled investment vehicles. You are getting exposure to many securities, not one.
Q. So ETF’s are like mutual funds?
A. Yes, in that you get exposure to many securities, but no, because traditional mutual fund shares don’t trade on exchanges; you purchase or redeem directly.
BY TYPE OF ISSUER
A debt instrument is a financial claim that requires payment(s) of interest and/or principal by the debtor to the creditor at a date, or dates, in the future. Debt securities are negotiable financial instruments serving as evidence of a debt.
Now, we divide an economy into five sectors* that are resident in the economy.
So, when we’re talking about the debt of an economy, one way we’ll be talking about it is by which of the five types of sector is the issuer (the debtor).
The five sectors are:
What about the Public and Private sectors?
Well, general government is obviously the public sector. But the public sector also includes those corporations controlled by the government. Then the private sector is everything else.
BY CURRENCY OF ISSUANCE
When we’re talking about the debt of an economy, a second way we’ll talk about it is by which currency the debt is denominated in. There are really just two types:
People talking about debt issued by residents of emerging economies talk about hard currency to mean one of a small group of external currencies including the US dollar, Euro, Yen and Pound Sterling.
BY TYPE AND RESIDENCY OF HOLDER
When we’re talking about the debt of an economy, the third way we’ll talk about it is by who the type and what the residency of the holder. It’s common to talk about the residency of the holder as having two types:
External Debt is the name for the debt liability of the whole of an economy, both the government (the public) sector, and the corporate and financial (the private) sector, with respect to the rest of the world (the external sector).
There is a common misperception that external debt is the name for debt denominated in an external currency. Better to call that external-currency debt.
To re-emphasise, external debt has a specific meaning in the Balance of Payment and International Investment Statistics: if a resident has a current liability to a nonresident that requires payments of principal and/or interest in the future, this liability represents a claim on the resources of the economy of the resident, and so is external debt of that economy. So when we are talking about market structure, then if we are thinking about debt markets and investor residence, we can use the term external debt. We should not use it to mean debt denominated in an external currency. Hence the term external-currency bond is reserved for the latter.
AN ECONOMY’S POSITION TO THE REST OF THE WORLD
The external sector is the economy’s position to the rest of the world. Positions are really stock variables – the situation at a point in time – and we’re interested in one particular aspect – to do with financial instruments – of an economy’s position to the rest of the world. It’s the international investment position, or IIP, which essentially tells you about two things:
Financial transactions between an economy’s residents and the rest of the world – i.e. transactions in equities and debt – are called capital flows, and when they occur they change the financial position between the economy and the rest of the world. They give rise to flow data, because we define flows data as the data arising when there’s a transaction in financial assets or liabilities. They are often broken down into four types:
These transactions are recorded in a countries’ financial account, which is part of a larger / broader set of accounts of transactions between an economy and the rest of the world called the Balance of Payments.
Sovereign debt default refers to when national governments default on their debt obligations. Like other types of debt, sovereign debt is a contractual obligation. A failure to meet this contractual obligation for scheduled interest and principal payments in full on the due dates provides one clear-cut example of a sovereign default*. Theoretical literature highlights a variety of factors that can trigger sovereign default and debt crises. On the one side, countries can be unwilling to repay their debt, based on an intertemporal optimization calculus. On the other side, countries can be unable to repay their debt because they are either insolvent or illiquid. Whether a sovereign is insolvent or not, depends on its stock of debt relative to its ability to pay, measured, for example, by GDP, exports, or government revenues. A sovereign is solvent, if the discounted value of future primary balances is greater or equal to the current public debt stock. Likewise, a country is solvent, if the discounted value of future trade balances exceeds the current stock of external debt*. Nevertheless, as government responses to financial distress can take many forms, sovereign defaults are often not so explicit. In some cases, we can conclude that, even without an actual interruption of debt service, a default has effectively occurred because actions by the sovereign result in economic losses by creditors*.
Data: the Bank of Canada (BoC) developed a comprehensive database of sovereign defaults that is posted on its website and updated in partnership with the Bank of England (BoE).
The foreign exchange (FX) reserves of an economy form part of the stock of ‘foreign’ financial instruments owned by an economy / the economy’s residents, and as such they form part of the assets side of the international investment position. They are a specific part: that part owned by the public sector (specifically, by the central bank or other monetary authority) owned not as an investment (to grow in value, and eventually be used for consumption) but held to be used as a policy instrument, generally as an instrument to manage the exchange rate.
Foreign exchange reserves are assets (usually financial assets, especially government bonds) denominated in foreign currencies held by an economy, generally by its central bank.
WHAT IS THE BALANCE OF PAYMENTS?
The balance of payments (BOP) is a statement of all transactions made between entities in one country and the rest of the world over a defined period of time, such as a quarter or a year.
|AMC||Asset Management Company|
|Asia Debt||the asset class that includes Sovereign and Corporate issuers domiciled in Asia.|
|CEMBI||a family of emerging markets corporate bond indices from JPMorgan. See our dedicated Emerging Market Indices page.|
|Clustering||Clustering analysis: theory gives a little background on clustering, which is a way of classifying one large set of things into several collections, in which each collection’s things are quite similar to each other but not quite so similar to those things in the other collections. For example you might have a large sack of fruit, and you can have a small bag for apples, a small bag for oranges, etc. See our Why clustering page.|
|Dedicated funds||funds which hold almost all their assets in a single asset class. For example, funds that are “Emerging Market Debt Dedicated”” will hold almost all their assets in the Emerging Market Debt asset class.”|
|EM Corporate (CEMBI)||a category we use internally at Trounceflow for funds dedicated to EM Corporate Debt, and where holdings are largely constrained to bonds eligible for the CEMBI.|
|EM Corporate Debt||debt issued by an EM corporate.|
|EMD Dedicated funds||funds that have almost all of their assets in EMD.|
|EMD Portfolio Flows||capital flows specifically in EM issued bonds (bonds are portfolio assets) across the EM / DM border.|
|EM Hard (EMBI)||a category we use internally at Trounceflow for funds dedicated to EM Hard Debt, and where holdings are largely constrained to the EMBI.|
|EM Local Debt||debt issued by an EM sovereign denominated in the local currency. Contrast this definition to GBIEMG*eligible debt, a narrower subset that excludes bills, lessliquid bonds, inflationlinked and floatingrate bonds, and the bonds of some emerging economy sovereigns.|
|EM Local Debt Portfolio flows||flows between EM and DM of EM Local Debt.|
|EM Local (GBIEM)||a category for funds dedicated to EM Local Debt, and where holdings are largely constrained to the GBIEMGD composition.|
|EM Undedicated||a category for funds that may hold debt from more than one EM Debt Sector. Sub categories include EM Undedicated (Blend), EM Undedicated (Total Return) and EM Undedicated (Short Duration).|
|External debt||debt held by nonresidents. It can be denominated in local or foreign currency. External debt can also be public debt (central or general government) or private debt.|
|Foreign currency debt (hard currency debt)||debt issued in a currency other than the local currency of the country. Typically it is in USD, EUR or JPY. Similarly, it can be public debt (central or general government) or private debt.|
|Fund Flows||the net subscriptions to, or redemptions from, mutual funds.|
|Portfolio Flows||crossborder transactions (capital flows) in portfolio assets, like bonds and stocks.|
|Separately Managed Accounts||investment vehicles of asset management companies that are managed separately from pooled vehicles like mutual funds and ETF’s. Often used by large investors (e.g. state pension funds) who have very specific mandates, and for whom the asset management companies’ standard products (mutual funds and ETF’s) are not appropriate.|
|Undedicated Asia Debt funds||funds which may hold debt from more than one EM Debt Sector; they may be Constrained to hold a blend of sectors in a certain ratio, or Unconstrained in their allocation to EM Debt Sectors.|
|Undedicated funds||funds which may hold debt from more than one EM Debt Sector; they may be Constrained to hold a blend of sectors in a certain ratio, or Unconstrained in their allocation to EM Debt Sectors.|
|Crore/Koti||denotes ten million (10,000,000 or 107 in scientific notation) and is equal to 100 lakh in the Indian numbering system. It is written as 1,00,00,000 with the local style of digit group separators (a lakh is equal to one hundred thousand and is written as 1,00,000).|