SUMMARY

INVESTOR BEHAVIOUR


 

The mission of Trounceflow is to deliver truth about the behaviour of investors and the impact that investor behaviour has on asset prices.
To get your head around this, you are going to need to understand some of the relevant concepts, so we’ve explained them here. Depending on your background, you might benefit from some basic training from finance and economics to get you going.
We’re interested in what works in practice, not in theory, so we explain some of the practical matters and empirical findings. 

 


 

SUMMARY

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.


CONCEPTS

CONCEPTS: FLOWS

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.

CONCEPTS: FLOWS

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:

  • The aggregate assets and liabilities for financial and nonfinancial sectors.
  • What sectors issue and hold financial assets (instruments) of a given type.

CONCEPTS: FLOWS

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.

CONCEPTS: FLOWS

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

CONCEPTS: POSITIONS

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.

CONCEPTS: POSITIONS

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.

CONCEPTS: MARKET STRUCTURE

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).

CONCEPTS: MARKET STRUCTURE

FOREIGN INVESTORS


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.

CONCEPTS: MARKET STRUCTURE

LOCAL INVESTORS


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.

SUMMARY

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.

IN PRACTICE: FLOWS

FUND FLOWS


Trounceflow makes fund flow data.

IN PRACTICE: POSITIONS

FUND FACTSHEETS


Mutual funds and ETF’s publish fund factsheets that set out the asset allocation of the fund.

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.

IN PRACTICE: POSITIONS

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.

IN PRACTICE: POSITIONS

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.

IN PRACTICE: POSITIONS

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 PRACTICE: POSITIONS

BOND INDICES

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).

The FTSE World Government Bond Index (WGBI) measures the performance of fixed-rate, local currency, and investment-grade sovereign bonds. The WGBI is a widely used benchmark that currently includes sovereign debt from over 20 countries, denominated in a variety of currencies, and has more than 30 years of history available. The WGBI provides a broad benchmark for the global sovereign fixed income market. Sub-indexes are available in any combination of currency, maturity, or rating.

 

The Bloomberg Barclays Global Aggregate Index (Global Agg) includes treasury, government-related, corporate and securitized fixed-rate bonds from investment grade developed and emerging markets issuers.

If the local sovereign debt of a currency is not eligible for the index, then no other securities denominated in that currency will be eligible, regardless of the securities’ issue-level ratings.

 

The Bloomberg Barclays US Aggregate Bond Index includes investment grade, US dollar-denominated, and fixed-rate Treasuries, government-related and corporate securities, MBS (agency fixed-rate and hybrid ARM pass-throughs), ABS and CMBS (agency and nonagency).

 

The Bloomberg Barclays Multiverse Index provides a broad based measure of the global fixed income bond market. The index is the union of the Global Aggregate Index and the Global High Yield Index as it represents investment grade and high yield bonds in all eligible currencies.

 

The J.P. Morgan GBI EM series provides a comprehensive measure of local currency denominated, fixed rate, government debt issued in Emerging Markets. The three main composite indices are GBI-EM, GBI-EM Globaland GBI-EM Broad, each having a Diversified version.

 

The J.P. Morgan EMBI Global/ EMBI Global Diversified series comprises of USD denominated Brady bonds, Eurobonds and Traded loans issued by sovereign and quasi sovereign entities. The Diversified version limits the weights of the index countries by only including a specified portion of those countries’ eligible current face amounts of debt outstanding

The J.P. Morgan CEMBI/CEMBI Broad index series was created in response to investor demand for a liquid global emerging market corporate benchmark and the rapid increase in corporate issuance. The Diversified versions of the CEMBI/CEMBI Broad indices limits the weights of the index countries by only including a specified portion of those countries’ eligible current face amounts of debt outstanding.

The J.P. Morgan Asia Credit Index (JACI) measures the performance of Asia ex Japan USD denominated bond market. JACI provides a benchmark for investment opportunities in fixed and floating rate US dollar-denominated bonds issued by Asia sovereigns, quasi-sovereigns and corporates.

The J.P. Morgan Next Generation Markets Index tracks USD-denominated debt issued by sovereign and quasi-sovereign next generation issuers. The index provides a benchmark for the smaller, less liquid population of emerging market credits, where investment opportunities in external debt markets are limited relative to the larger, more traditional emerging economies where external debt issuance is frequent and large

IN PRACTICE: POSITIONS

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:

  • The market of the sovereign bond must be easily accessible to foreign investors
  • Coupon should be fixed with a minimum maturity of 1 year
  • Market size of the sovereign bond should be a minimum of 50 billion USD
  • Minimum credit of A- by S&P and A3 by Moody’s

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:

  • Country exclusion or inclusion in the index or
  • Change of a country’s weight in the index

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
Australia Mexico
Austria Netherlands
Belgium Norway
Canada Poland
Denmark Singapore
Finland South Africa
France Spain
Germany Sweden
Ireland Switzerland
Italy United Kingdom
Japan United States
Malaysia  

IN PRACTICE: DATA PROVIDERS

PROVIDERS


Provider Fund allocations   Fund flows
Portfolio flows
Market structure  
Trounceflow   Daily    
IIF        
JPMorgan Research Survey data EPFR    
Bank of America Monthly      
Other Sell-side Research   EPFR    
Morningstar   Monthly    
Refinitiv Lipper        
Bloomberg   ETF only    
IMF        
Macrobond        
Crowdthnk        
BNY Mellon        
BIS Locational Banking Statistics        
BIS Consolidated Banking Statistics        
KP dataset        

IN PRACTICE: DATA PROVIDERS

PROVIDERS


Provider Flow Stock Asset Allocation
Fund Flows Portfolio Flows Capital Flows Public Debt External Debt Market Structure Dedicated Undedicated
Trounceflow                
IIF                
JPMorgan Research EPFR              
Bank of America                
Other Sell-side Research EPFR              
Morningstar Monthly              
Refinitiv Lipper                
Bloomberg ETF only              
IMF                
Macrobond                
Crowdthnk                
BNY Mellon                
BIS Locational Banking Statistics                
BIS Consolidated Banking Statistics                
KP dataset                

IN PRACTICE: DATA PROVIDERS

FLOWS & POSITIONS DATA VENDORS

  • Data Provided

   

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.

  • Data Provided

 

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.

  • Data Provided

   

Under Construction!

  • Data Provided

 

Under Construction!

  • Data Provided

 

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.

  • Data Provided

 

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.

  • Data Provided

       

Under Construction!

IN PRACTICE: ACADEMIC RESEARCH

Push Factors and Capital Flows to Emerging Markets


Why Knowing Your Lender Matters More Than Fundamentals?

Author/Editor: Cerruti, E., S. Claessens, and D. Puy (2015)
Series: IMF Working Paper 5/127, Washington, DC

Summary:

  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.  


IN PRACTICE: ACADEMIC RESEARCH

Multi-Sector Bond Funds Risks in Emerging Markets


Do Multi-Sector Bond Funds Pose Risks to Emerging Markets?

Author/Editor: Fabio Cortes, Luca Sanfilippo. (2020)
Series: IMF Working Paper 20/152 , Washington, DC.

Summary:

“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.”


IN PRACTICE: ACADEMIC RESEARCH

Differential Treatment in the Bond Market


Sovereign Risk and Mutual Fund Portfolios

Author/Editor: Converse, Nathan, and Enrico Mallucci (2019)
Series: International Finance Discussion Papers 1261.

Summary:

“The results are supportive of models of sovereign default that assign a nontrivial role to the preferences of international creditors.”


IN PRACTICE: ACADEMIC RESEARCH

Capital Flow Data


A Guide for Empirical Analysis and Real-time Tracking

Author/Editor: Robin Koepke; Simon Paetzold

Summary:

  • A guide for academics who embark on empirical research projects and for policymakers who need timely information on capital flow developments to inform their decisions
  • We address common misconceptions about capital flow data and discuss differences between high-frequency proxies for portfolio flows
  • High-frequency proxies have significant predictive content for portfolio flows from the balance of payments (BoP)
  • We also construct a new dataset for academic use, consisting of monthly portfolio flows broadly consistent with BoP data.

IN PRACTICE: ACADEMIC RESEARCH

The Role of Benchmark-Driven Investors


Emerging Market Portfolio Flows : The Role of Benchmark-Driven Investors

Author/Editor: Serkan Arslanalp and Takahiro Tsuda (2015)
Series: Working Paper No. 15/263

Summary:

“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.”


IN PRACTICE: ACADEMIC RESEARCH

Drivers of Capital Flows to Emerging Markets


What Drivers Capital Flows to Emerging Markets? A Survey of the Empirical Literature

Author/Editor: Robin Koepke

Summary:

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.


IN PRACTICE: ACADEMIC RESEARCH

Update on Benchmark-Driven Investors


Benchmark-Driven Investments in Emerging Market Bond Markets – Taking Stock

Author/Editor: Serkan Arslanalp, Dimitris Drakopoulos, Rohit Goel, and Robin Koepke

Summary:

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.


IN PRACTICE: ACADEMIC RESEARCH

Emerging markets and cross-border financial plumbing


Emerging Market Securities Access to Global Plumbing

Author/Editor: Gongpil Choi, Federico Ortega and Manmohan Singh

Summary:

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

 

IN PRACTICE: ACADEMIC RESEARCH

THE GLOBAL CAPITAL ALLOCATION



SUMMARY

INVESTOR BEHAVIOUR: BASIC TRAINING

 
 

BASIC TRAINING: THE INVESTMENT INDUSTRY

WHAT IS A MUTUAL FUND?


  • A mutual fund is a type of investment vehicle consisting of a portfolio of stocks, bonds, or other securities.
  • Mutual funds give small or individual investors access to diversified, professionally managed portfolios at a low price.
  • Mutual funds are divided into several kinds of categories, representing the kinds of securities they invest in, their investment objectives, and the type of returns they seek.
  • Unlike stock, mutual fund shares do not give its holders any voting rights. A share of a mutual fund represents investments in many different stocks (or other securities) instead of just one holding.
  • the price of a mutual fund share is referred to as the net asset value (NAV) per share
  • A fund’s NAV is derived by dividing the total value of the securities in the portfolio by the total amount of shares outstanding.
  • Outstanding shares are those held by all shareholders, institutional investors, and company officers or insiders.
  • Mutual fund shares can typically be purchased or redeemed as needed at the fund’s current NAV, which—unlike a stock price—doesn’t fluctuate during market hours, but it is settled at the end of each trading day.

BASIC TRAINING: THE INVESTMENT INDUSTRY

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.

BASIC TRAINING: DEBT & THE ECONOMY

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:

  • Nonfinancial corporations
  • Financial corporations
  • General government
  • Households
  • Nonprofits serving households

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.

THE DEBT OF AN ECONOMY: BY TYPE OF ISSUER (image)

BASIC TRAINING: DEBT & THE ECONOMY

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:

  • the economy’s own currency: the local currency
  • another currency: an external currency

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.

THE DEBT OF AN ECONOMY: BY CURRENCY OF ISSUANCE (image)

BASIC TRAINING: DEBT & THE ECONOMY

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:

  • domestic (local) holders: residents
  • external (foreign) holders: non-residents

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.

Debt of an Economy by type and residency of holder

BASIC TRAINING: THE EXTERNAL SECTOR

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:

  • the stock of ‘foreign’ financial instruments an economy’s residents own – these are assets
  • the stock of ‘local’ financial instruments owned by residents of other economies – these are liabilities

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:

  • Residents could buy ‘foreign’ instruments – e.g. Mexican pension funds buy US government bonds from Canadian pension funds (which would be a bond portfolio inflow for Canada)
  • Residents could sell ‘foreign’ instruments – e.g. Brazilian hedge funds sell Polish equities to Polish banks (which would be an equity portfolio outflow for Brazil)
  • Residents could sell ‘local’ instruments – e.g. Danish banks sell Danish government bonds to South African insurance companies (which would be a bond portfolio inflow for Denmark)
  • Residents could buy ‘local’ instruments – e.g. British banks buy UK Gilts from French asset managers (which would be a bond portfolio outflow for France)

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.

AN ECONOMY'S POSITION TO THE REST OF THE WORLD (image)

BASIC TRAINING: THE EXTERNAL SECTOR

Sovereign debt


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).

BASIC TRAINING: THE EXTERNAL SECTOR

FX RESERVES


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.

BASIC TRAINING: THE EXTERNAL SECTOR

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.

Glossary

Glossary Table


Abreviation Definition
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).