April 15, 2018
Dear Friends and Colleagues,
Last week, we hosted our second Capital Flow Round-table at the Harvard Club in NY, to discuss major emerging market themes with clients and special guests (Tony Volpon, Eric Baurmeister and Craig Feldman). Beyond a broad conversation about EM as an asset class, the major topics were (1) the increased financial integration of China (including index inclusion) and (2) the prospects for reform in Brazil and bullish flow dynamics.
We are very focused on collecting and analyzing high quality data in this space, including our proprietary tracking methods for EM FX positioning. But a discussion with different, smart perspectives can increase the value of that data many times over.
Our key takeaways on China & Brazil are summarized below:
On China, the conversation was focused on financial liberalization, including ongoing developments around China’s inclusion in global bond and equity indices.
On the equity side, it appears that index inclusion has been a smooth process thus far. This is also confirmed by our proprietary data, which shows that a majority of MSCI EM tracking funds are significantly overweight China-A shares vs the benchmark (though not fully at the target weights for year-end 2019).
On the bond side, the ride has been less smooth; with even the large asset managers seemingly having trouble getting comfortable with the logistics around accessing the onshore bond market. Relatedly, it seems likely that many funds may choose to adjust their benchmarks (to instead use ex-China ones) or customize China weights (lower) in other ways. Our analysis had already suggested only a moderate amount of flows into Chinese bonds on the back of the Bloomberg Barclays index inclusion, and the discussion at this event suggests there may be further downside risks to our below-consensus numbers.
On Brazil, not unexpectedly, the conversation was focused on sentiment and flows related to President Bolsonaro’s reform agenda. While foreign investor flows into equity markets seemingly remain subject to pension reform being approved (except perhaps in FDI space), the implications of the current ‘low carry’ regime are interesting, and potentially very important.
On the one hand, lower rates related to reduced domestic risks (political and inflation), combined with low global rates has led EM bond funds to generally hold overweight positions in the BRL. On the other hand, the regime shift away from double-digit BRL rates has potential implications for the (very large) domestic asset management industry. The size of the bond fund universe in Brazil is over BRL 2trn, and over 6x the size of the equity fund universe. If rates remain structurally low, these proportions will likely shift and could have significant implications for asset prices in Brazil.
Overall, we left with many interesting perspectives, including further concern around Chinese bond inflows and an increased focus on the implications of lower BRL rates, including on the Brazilian asset management industry and the funding decisions of Brazilian corporates.
More generally, we continue to find these events invaluable for enhancing our data-centric approach to financial markets. We intend to continue hosting these events roughly 2-3 times a year (and we are looking to do our first round-table outside NYC also). Let us know if you would like to be invited to future events or collaborate in some other form. As a start, you can sign up for future briefings using the link below.
President & Head of Research