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Behind fixed income flows

Skittish investment in high yield bonds and robust demand for emerging market debt led the action by European bond funds over the last year. Will this trend continue?


David Robinson

In case you were wondering where the action has been in bond markets over the last year we have collated data from Morningstar over the 12-months to January 2018 charting net inflows and outflows of the top European bond funds.

The stand-out trend was the sharp volatility in high yield bonds – typically issued by start-ups or capital-intensive firms with heavy gearing – with inflows in excess of €4bn in the first two months of 2017. This was followed by outflows of €2-6bn in March and July and November – punctuated by inflows of €1-2bn at other points in 2017.

Commenting on these trends, UBS global macro strategist, Lefteris Farmakis said: “It’s one of the idiosyncrasies of the asset class”.

“The lower the credit quality of a particular asset class the more volatile the pattern of flows tends to be,” he said.

The big outflow of more than in €5bn November could be attributed to pending changes to the US tax code and premature concerns about corporate debt levels and stretched valuations that pre-empted the market correction at the start of 2018.

The rollercoaster of outflows and inflows into high yield debt is likely to continue in 2018.

EM debt bonanza

The skittish investor attitude to high yield bonds stands in contrast to solid net inflows into emerging market debt throughout the 12-month period generally exceeded €4-6bn. There were particularly robust inflows in Spring 2017 and there was a spike in inflows in September (more than €7bn) and November (over €8bn).

“It has been a good year for emerging markets, Synchronised global growth buoyed investment in emerging markets supported by a robust Chinese economy that encouraged growth in other emerging markets in Asia,” Farmakis said. “At the same time inflation stayed relatively low so central banks were in no rush though big hikes in interest rates.”


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Source: Morningstar

It is debatable whether the robust inflows into emerging market debt will continue throughout 2018.

Bond issuance by governments and companies in emerging markets shows no sign of slowing down and as the US Federal Reserve returns to a more conventional monetary policy — with more rate rises are expected this year – there are concerns about whether some emerging economies will be able to service their growing debt piles.

It all hangs on China

“The elephant in the room with regards to emerging markets is always China,” Farmakis said.

China’s economy outperformed expectations last year – with GDP growth of 6.9% – and its size and influence means it has a systemic impact on all emerging markets.

“China’s growth rates are abnormally high compared to a long-term sustainable level and intervention by the authorities [to maintain this growth] is fairly high which carry additional risks. The debate about how and when this will change is pretty intense.”

The 12-month period also saw consistent robust net inflows – mostly above €6bn and exceeded €8bn for five of the months – into unconstrained bond funds investing across a range of fixed-income assets. “It was a pretty good year for fixed income across the board and inflows into unconstrained bond funds reflect this,” Farmakis added.

The interest in high-yield and emerging market debt has of course been encouraged by the low yields available on developed market government bonds which saw comparatively low inflows and outflows (often less than €1bn either way) during the 12-month period. Developed market corporate bonds, meanwhile, saw steady but unspectacular inflows (generally between €2-3bn) during the 12-month period.