“Narrowing short-term interest rate differentials, expectations of a December Fed rate hike, uncertainty about U.S. tax policies, and profit-taking after strong gains this year” are to blame for that, according to the Institute of International Finance (IIF).
Focus on Mexico
The IIF, an umbrella organisation of commercial financial institutions, also pointed to a number of “idiosyncratic events”. It noted that allocations to Mexican assets as a percentage of total portfolios have reached their lowest level in more than six years, “now accounting for only 3.8% of investors’ EM portfolio”. It attributed this to the growing risk of a breakdown in ongoing NAFTA re-negotiations.
Frank Reisbol, managing director at Banque Carnegie in Luxembourg, is undeterred however. He took a large position in Mexican local currency bonds at the start of the year, and recently increased that position on currency weakness.
“With decent yields quite hard to come by, we believe that this is one of the areas where you might be well rewarded as a euro-based investor,” he says.
“With decent yields quite hard to come by, we believe that this is one of the areas where you might be well rewarded as a euro-based investor” - Frank Reisbol
Investors seem convinced of the necessity to hold EM bonds to access yield. But it looks they are taking some risk off the table as we approach the end of the year. Currency risk, in particular.
As EM currencies have been weakening recently, investors have responded by increasing their hard currency holdings at the expense of local currency. While EM debt overall saw net inflows in October, local currency bond funds suffered net outflows of €436m (following net inflows of €1.5bn in September).