* New breed of investors not tied to standard benchmarks
* Preference for funds investing in range of asset classes
* Single-country crises less likely to spell broader
By Sujata Rao
LONDON, July 18 New types of long-term investors
and flexible, "go-anywhere" investing styles are helping
transform emerging markets by making the once-volatile sector
less prone to the sweeping sector-wide sell-offs common in the
Consider recent events. Macedonia and South Africa
successfully tapped bond markets on July 17, as buyers turned a
blind eye to the ongoing Russian bond rout caused by U.S.
sanctions and the bringing-down of a passenger plane on its
border with Ukraine.
Similarly, a day after a U.S. court ruling put Argentina on
the road to default, fellow emerging market and serial defaulter
Ecuador persuaded bond investors to lend it $2 billion.
And the bank crisis and resulting stock market tumble in
Bulgaria made barely a ripple in neighbouring Romania or
Not so long ago, the sector would have swooned in unison, as
during the Argentine debt default in 2001-02, the Russian
financial crisis of 1998, and banking crises in Turkey in 2001
and Iceland in 2008.
But increasingly, the new normal is for contagion between
markets to be either absent altogether or modest and
All that applies to the riskier Western markets, too -
recent pockets of volatility such as those caused by problems at
Portugal's Banco Espirito Santo sparked some selling
but did not translate into across-the-board routs that shook out
bullish bets on Spain or Italy.
Some of investors' nonchalance is down to the flood of cheap
money still being pumped out by developed central banks.
But fund managers reckon steady inflows from big long-term
investors such as pension funds - and their preference for
flexible, benchmark-agnostic investment models - is helping
emerging markets weather the kind of storms that would have
flattened them, domino-style, just a few years ago.
"The institutional side has been pretty resilient through
all this," said Ernesto Bettoni, director and strategist in
BlackRock's emerging debt team in London.
"Institutional investors did not capitulate on emerging
markets, but what is changing is the way they invest. We have
noticed a lot of them are excited by unconstrained strategies,"
he said, referring to so-called "go anywhere" funds that eschew
the old benchmark-based investing models.
WHO IS BUYING EMERGING MARKETS AND HOW?
There is evidence that deep-pocketed pension and sovereign
funds, insurance firms and central banks - who a decade ago
would have shunned emerging markets as too risky - have been
buying. Their allocations via mutual funds to emerging equities
currently are 9 percent above year-ago levels, data from the
Washington DC-based Institute of International Finance shows.
Emerging bond allocations are up 7.5 percent, the IIF says.
Adjusted for price changes, allocations to emerging markets
via mutual funds are more than three times as high as they were
in 2007 in dollar terms, this graphic, based on IIF data, shows:
Consultancy Mercer's annual survey of investors managing 850
billion euros also showed this year that allocation to emerging
markets had risen since its previous poll.
"Institutional investors have ... taken a relatively
sanguine view of the difficulties experienced by many emerging
economies in 2013. This stands in stark contrast to the sudden
rush for exit by retail investors," Mercer concluded.
But as Bettoni says, it's not just who is investing but how
they are doing it.
Mass-scale selling that regularly torpedoes emerging equity
and bond markets is partly down to the practice of
mark-to-market, where the net asset value or NAV of a fund is
computed on a daily basis, based on its latest market value.
That often leads fund managers, struggling with one poorly
performing asset, to sell down others in the index to preserve
profits and prevent a mass exodus of investors from their fund.
But many of the new breed of investors don't measure
themselves against standard benchmarks, favouring funds that can
invest across asset classes. In such a fund, Brazilian bonds can
reside cheek-by-jowl with UK stocks or German Bunds.
"Where we are seeing the most inflows is unconstrained
emerging debt, and that's from institutional investors who are
already familiar with EM debt," Bettoni said.
Data from EPFR Global bears this out. Blended funds that
switch between local- and hard-currency emerging bonds have
accounted for the lion's share of inflows this year, which
analysts say suggests a desire for non-benchmark focused funds.
A global multi-asset income fund from Schroders has amassed
$5 billion since its 2012 launch. Fund manager Aymeric Forest
ascribes this partly to pension funds' need for steady income.
The fund now has a fifth of its assets in emerging markets
up from an 8 percent low, yet its volatility is 5-7 percent,
compared with the 10-12 percent that is typical for many
dedicated emerging debt funds, Forest says.
"When you buy a benchmark you buy concentrated risk ... you
may be buying large market cap stocks or bonds from countries
that issue a lot of debt," Forest said. "We are not forced to
own any particular asset class or security."
CUSTOM-MADE AND DIFFERENTIATION
Others may prefer custom-tailored indexes - equity index
provider MSCI reports that requests for customised indexes have
risen by 50 percent over the past year.
Jeremy Brewin, head of emerging debt at ING Investment
Management, recounts how his fund had created an emerging debt
benchmark that omitted Argentina for one institutional client.
"In the last couple of years, specific clients with specific
needs have come to the market," Brewin said. "We no longer just
offer a big red car; if they want a small green car with red
spots, we can give them that."
Brewin and other investors are under no illusion that
emerging markets will be immune to Lehman-style cataclysms in
the West or even to big and sudden U.S. rate rises.
But all say there is some recognition, even among investors
not specialising in emerging markets, that, say, an Argentine
default will not necessarily tip Peru or Ecuador over the edge.
That was evident even last year when investors meted out
brutal punishment to weak economies such as India or Turkey
while others such as Poland or Mexico escaped lightly.
"There is a lot more dispersion now within emerging markets;
there are good clubs and bad clubs; some are reformers, others
are not, and all that is new. You need to discriminate between
them, and we are seeing this already this year," Bettoni said.
(Graphic by Vincent Flasseur; Editing by Will Waterman)