Crossover investors boost EM debt despite misleading flow data

Bank of America maintains a bullish view on emerging market (EM) assets, noting strong year-to-date performance, particularly in EM debt, which has outperformed US Treasuries since the pandemic. Despite traditional fund flow data suggesting otherwise, broader measurements reveal significant inflows, driven by non-dedicated global investors now acting as 'residents' due to improved EM fundamentals and credit ratings. This shift towards more stable crossover positions underscores EM debt's growing importance, now representing approximately a quarter of global tradable debt.

Analysis

Bank of America reiterates its structurally bullish view on emerging market (EM) assets, highlighting a significant disconnect between traditional fund flow data and actual market performance. While conventional metrics suggest weak investor interest, the bank's analysis indicates that broader flow measurements reveal substantial capital allocation to the sector. This is evidenced by the strong year-to-date performance of EM debt, which has notably outpaced US Treasuries since the COVID-19 pandemic. The core driver of this trend is a structural shift in the investor base; non-dedicated investors, previously considered transient "tourists," are now establishing more permanent "resident" positions. This change is attributed to improving fundamentals and credit ratings across the EM universe, making the asset class more accessible to large, global funds. Consequently, these stable crossover positions are seen as a stabilizing force for EM debt, which has grown to represent approximately one-quarter of all globally tradable debt.

Key Decisions for Investors

• Investors should look beyond traditional EM fund flow data, which appears to be a lagging or incomplete indicator, and instead focus on the strong underlying performance and fundamentals when assessing allocations to emerging market debt.
• Consider gaining EM exposure through broad-based global bond funds, as the analysis indicates these are a primary and increasingly stable source of capital for the asset class, rather than relying solely on dedicated EM funds.
• Monitor the trajectory of EM sovereign credit ratings and fundamentals, as their continued improvement is the key catalyst attracting the sticky, non-dedicated capital that is stabilizing and supporting the asset class.