Investors quit emerging markets for developed safety

LONDON (Reuters) - Investors are responding to the sharp falls on equity markets around the world by shifting from what are now being seen as vulnerable emerging markets to relatively safer developed ones.

The moves -- which can be seen in a variety of investment flow data -- are evidence that an earlier belief that emerging economies and markets could decouple from troubles in the dominant U.S. economy is on rocky ground.

In its monthly poll of fund managers, released last week, Merrill Lynch noted that there are now more investors overweight U.S. equities than there are those who are overweight emerging markets.

This is a complete reversal from just three months ago and turns the trend of the past few years on its head.

Six months ago in January, for example, only 24 percent of Merrill's respondents were overweight U.S. stocks versus 53 percent who favored emerging markets. Wednesday's numbers inverted to 40 percent and 30 percent, respectively.

State Street reports that its institutional investor clients have been deserting emerging markets, preferring developed bourses as a safe-haven play within the asset class.

"Emerging markets outflows from institutional investors have now reached a new peak," said Jeremy Armitage, head of research at State Street Global Markets.

Looking at Latin America, for example, State Street finds inflows currently only in the 13th percentile -- that is, they have been stronger 87 percent of the time over the past decade or so.

In February, Latin America inflows were in the 66th percentile.

By contrast, investment flows into developed markets were at near record lows in February -- in the 2nd percentile -- but are now in the 92nd, almost as high as they have even been.

Fund tracker EPFR Global, meanwhile, saw money flowing into U.S. equities in the week up to last Wednesday to the tune of a net $2.64 billion, adding to $2.58 billion a week earlier.

DIVERGENCIES

Before a recovery late last week, stock markets in both developed and emerging markets were falling sharply in the general maelstrom of investor worry about slowing economies, rising inflation, geopolitics, banking, and monetary policy gyrations.

MSCI's developed stock market index .MIWO00000PUS, however, has outperformed its emerging market counterpart .MSCIEF over the past month by 220 basis points, losing 4.4 percent versus an emerging market loss of 6.6 percent.

Investors are not, however, simply indulging in an across-the-board shift from one asset class to another.

State Street's Armitage said there were considerable regional differences within the emerging market outflows tracked by his firm.

"Certainly Asia and Latam are witnessing extremely negative sentiment," he said.

"(But) Eastern Europe ... is still attracting considerable foreign investment as these countries are sandwiched between Russia, with its new commodities wealth, and Germany's still relatively robust economy."

This gells with general comments from investors in emerging markets that they are being pickier than they used to be in deciding where to put their money.

German fund DWS said last week, for example, that it favored Chinese stocks over Indian ones because it believes China is better placed to cope with higher inflation and slower growth.

Others have shifted from a general focus on emerging markets to favoring those with large current account surpluses.

SAFETY FIRST

Nonetheless, money is flowing into developed markets. So the big question for investors is whether it reflects a belief that U.S. and other developed bourses are due a rebound or simply a desire to get away from potentially vulnerable emerging markets.

The tentative answer would seem to be that it is primarily the latter. State Street says the flows it tracks amount to a "safety first" mood while the Merrill poll's risk indicator was in "extreme" aversion territory.

Furthermore, EPFR Global has noted that the money that is flowing into U.S. stocks is predominately landing in large and small cap blend exchange traded funds and in safer, value-oriented funds rather than growth ones.

But flows change things no matter what the motivation. So the mere fact that money is flowing from emerging to developed markets is likely to be a fillip for the latter.

Indeed, this may already be happening. MSCI's emerging market index has lost 0.6 percent in the past week. The developed market index has gained 1.9 percent.

(Additional reporting by Nishant Kumar and Jeffrey Hodgson)