Top Emerging-Market ETF Hit by Record Outflow as Central Banks Signal Tighter Policy

By Saumya Vaishampayan Features Dow Jones Newswires

A record amount of money flowed out of a major emerging-market exchange-traded fund last week, a sign that some investors may be growing skittish about owning risky assets in an environment where global interest rates are set to rise.

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Investors pulled a net $818.5 million out of the iShares J.P. Morgan USD Emerging Markets Bond ETF in the five days through Friday, the biggest weekly outflow since the fund was launched in 2007, according to data from FactSet. The $11.7 billion fund is the largest emerging-markets bond ETF by total assets, according to ETFdb.com, which tracks such funds.

The exodus of money from emerging-market dollar debt followed comments from central bankers in the U.K., Canada and the eurozone suggesting that their economies have recovered enough for them to consider stepping back from their easy monetary policies. Yields on benchmark government bonds in the U.S. and Germany have since rallied, with the 10-year bund recently hitting its highest level since early 2016.

To be sure, weekly flows for ETFs can be volatile. The iShares emerging-market ETF in question received a net inflow of $899.8 million in the five days ended June 9, the biggest weekly inflow in the fund's history, the data show. Even with last week's withdrawal, investors have poured a net $3.6 billion into that fund so far this year.

In the wake of the 2008 global financial crisis, many major central banks bought bonds aggressively as they tried to stabilize their economies, helping drive yields lower. The Federal Reserve has since reversed course, ending its bond purchases and raising short-term interest rates. It now appears likely that more central banks in developed markets are ready to tighten monetary policy as well.

Investors turned to risky assets that offer higher returns, such as those in emerging markets, as rates dropped to ultralow levels around the world in part because of central banks' bond purchases. The question now is whether those yield-hungry investors will continue to want to own emerging-market debt as returns on safer assets become more appealing. Signals from the Fed in 2013 that it was ready to end its asset purchases hit emerging markets hard in an episode known as the taper tantrum. At the time, investors unloaded bonds in an effort to pre-empt the Fed's scaling back of its stimulus program.

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The 10-year Treasury yield settled at 2.371% on Monday in New York. A rise in the 10-year Treasury yield to near 3% could be a more significant trigger for a reversal of fund flows, said Khoon Goh, head of Asia research at ANZ. As developed-market yields rise, "we could see at the very least some unwinding of the strong inflows," he added.

Foreign investors have snapped up emerging-market debt in Asia, excluding China, in each of the first six months of the year, according to ANZ, sending $6.1 billion into those bonds in June alone. The pace has cooled recently, however, with last month's amount marking the smallest monthly inflow since March.

Kisoo Park, a global bond manager at Manulife Asset Management in Hong Kong, said global rates would probably rise more than many market participants currently expect, but not to absolute levels high enough to spur large outflows from emerging markets.

"You want to be in a country that has an improving fundamental trend and high yields, like Indonesia and India," he said, adding that he owns bonds in both countries.

Write to Saumya Vaishampayan at saumya.vaishampayan@wsj.com

(END) Dow Jones Newswires

July 11, 2017 08:11 ET (12:11 GMT)