Institutional investors are pouring billions of dollars into emerging market securities this year.
Emerging market debt grabbed the lion's share — more than $3 billion as of May 31. Emerging market equity is just starting to catch fire, getting $463 million in the five weeks ended June 18, according to data from EmergingPortfolio.com. Prior to that, inflows had been negative for the year.
This is a dramatic switch from the first half of 2002. Then, inflows into emerging market debt totaled a mere $403.6 million, while inflows into emerging market equity came to $87.5 million.
"The pipeline of searches and interest in emerging markets has increased dramatically," said Narayan Ramachandran, head of emerging markets equities at Morgan Stanley Investment Management, New York. "There should be more tangible interest and meaningful flows into emerging markets equities over the next two to three years."
Among the searches and hirings so far this year:
-- The $68 billion New York City Retirement Systems will select two money managers this fall to manage $700 million in emerging market equities;
-- Alfred I. duPont Testamentary Trust & the Nemours Foundation, Jacksonville, Fla., hired Lloyd George Asset Management, London to run a $45 million emerging markets equity portfolio for the $2.7 million endowment;
-- City of Zurich Pension Fund is looking for a manager to run a 50 million Swiss franc ($37 million) emerging markets equity mandate for the 10 billion franc pension fund;
-- The Abu Dhabi Investment Authority hired three emerging market debt managers to run a combined $1 billion in assets. The authority, with estimated total assets of $50 billion, hired UBS Global Asset Management, New York; Pacific Investment Management Co., Newport Beach, Calif.; and BridgePoint Capital Resources, New York;
-- The $4 billion San Diego County Employees' Retirement Association hired Ashmore Investment Management Ltd., London, for a $151 million emerging markets mandate;
-- Capital University in Columbus, Ohio, hired State Street Global Advisors, Boston, to manage an active emerging markets equity portfolio for its $34 million endowment;
-- The $180 million Brockton (Mass.) Contributory Retirement System recently hired The Boston Co. Asset Management to run a $5 million emerging markets equity portfolio for the $180 million pension fund;
-- Duke University's $4 billion endowment, Durham, N.C., gave a $75 million mandate to Ashmore this year; and
-- Stichting Lucent Technologies Pensioenfonds, Amsterdam, the €450 million ($517 million) pension fund of Lucent Technologies' Dutch subsidiary, hired Bridgewater Associates Inc., Westport, Conn., and Ashmore to each manage a $26 million mandate in emerging market local currency debt.
The biggest asset management players in emerging markets debt include PIMCO, which pulled in more than $1 billion in new money through May 31 for its portfolios; Ashmore, about $1 billion; J.P. Morgan Fleming Investment Management Inc., New York, about $792 million; Morgan Stanley Investment Management, about $340 million; Citigroup Asset Management, New York, about $250 million; and Grantham Mayo Van Otterloo & Co., LLC, Boston, about $200 million.
Mohamed El Erian, head of emerging market debt investments at PIMCO, said the "search for yield" is an important element in the growth of emerging markets debt allocations.
He said 40% of emerging market debt is rated investment grade, but still has spreads of about 500 basis points over U.S. Treasury securities.
"There is a long-term repricing of the asset class, consistent with its improving fundamentals," he added.
Investing in emerging markets debt "is part of a longer-term trend of people seeking alpha from other parts of their portfolios, including fixed income," said Abigail McKenna, director of emerging markets debt at Morgan Stanley Investment Management.
The J.P. Morgan Emerging Market Bond index was up 17.35% as of May 31, while the Lehman Aggregate Bond index was up 1.39% for the first quarter of 2003. And a new Morgan Stanley report predicts the average annualized return for emerging market debt during the next five years will be 7.9%.
Jerome Booth, Ashmore's director of research, said the firm expects to take in another $1.5 billion in emerging market debt assets by the end of 2003. He said some investors are waiting for a dip in interest rates in emerging markets debt before they make their investments — "but that's not going to happen."
"Emerging market debt is still cheap compared to other fixed-income credit markets," he added.
At J.P. Morgan, most of the firm's new money earmarked for emerging markets debt has come from European institutional investors, with some of it from European and U.S. union pension funds, said Paul Dixon, portfolio manager of emerging markets debt at J.P. Morgan. Citigroup also has seen increased interest from European institutional investors, said Peter Wilby, chief investment officer-fixed income, North America.
On the equity side, it's the search for diversification that is driving the move to emerging markets.
Michael Musuraca, a trustee of New York City Retirement Systems, said at a recent investment conference that the fund is investing in emerging market equities as a way to diversify into an investment less correlated with traditional asset classes.
Harold Hanna, executive director of the Brockton pension fund, said his fund also was investing in emerging market equities to get more diversification: "Emerging markets equities should round out our portfolio with a mix of risky and correlated and non-correlated investments."
Emerging markets equity has actually been outperforming developed market equities for the last three years. The Morgan Stanley Capital International Emerging Markets Free index was down 2.37% in 2001 and 6% in 2002, while the MSCI Europe Australasia Far East index was down 21.21% in 2001 and 15.66% in 2002.
The MSCI Emerging Markets Free index is up about 16% for 2003 through June 30, while the EAFE index is up about 8%.
