Emerging Markets Can Manage Evolving Mix of Global Investors

Composition of global investors in emerging market stocks, bonds has been changing over the past 15 years

This new mix has made capital flows more sensitive to global financial shocks

Policies to deepen emerging market financial systems can help manage risks

In its latest Global Financial Stability Report, the IMF investigates the effects of changes in the mix of these global investors.

The role of bond funds—especially local-currency bond funds—has been on the rise since the early 2000s. Savers in advanced economies now increasingly channel their money through global mutual funds that invest both in advanced and emerging market economies. The participation of sovereign wealth funds and central banks in these financial markets is growing as well.

Back in the 1990s, by contrast, investing in emerging market economies mostly meant purchasing equity though funds specialized in these countries.

The IMF said that different investors behaved distinctively. During the sell-off of emerging market stocks and bonds in 2013 and early 2014, institutional investors such as pension funds and insurance companies with long-term strategies broadly maintained their emerging market investments. Retail-oriented mutual funds withdrew. Different types of mutual funds—such as those focused on bonds and equity—also have shown varying degrees of sensitivity to global financial turbulences.

“Knowing who the investors are is critical for understanding the evolving stability of capital flows into emerging markets, especially when the uncertainty over advanced economies’ monetary policy remains high,” said Gaston Gelos, Chief of Global Stability Analysis Division in the IMF’s Monetary and Capital Markets Department and the head of the team that produced the analysis.

No emerging market is an island

Changes in the mix of global investors in emerging market stocks and bonds are likely to make overall capital flows more sensitive to global financial conditions, according to the IMF.

The analysis found the share of more volatile bond flows had risen as more opportunities opened up to invest in emerging markets, and that larger direct foreign participation in local financial markets could transmit global volatility to local asset prices.

Investment from mutual funds is more sensitive to the ups and downs of global financial conditions than that of institutional investors. Many of the small investors putting money into mutual funds are less informed savers, who may...