Funds Flow & Asia

Getting In & Out

The correction in Asia in particular, and global markets in general, caused some panic buttons to be pushed. For a time it looked like the markets may be headed for the abyss should the yen continue to strengthen or US numbers indicate a hard landing scenario. Thankfully sanity prevailed, or in my other blog, the Plunge Protection Team came to the rescue to buy time for investors to rethink their positions and to take the fear element out of the market equation.

However, some damage has been done. It is inevitable that there will be some redemption of funds being invested in emerging markets everytime fear and risk rear their ugly heads. For the first 7 days of March, a check with the funds which are dedicated to investing in Asia (except Japan) showed a startling redemption of US$4 billion. The redemption affects investments by these funds into China, Korea, Malaysia, Singapore, India, HK, the Philippines, Thailand, Taiwan and Indonesia. To quote the Citigroup report: "China funds experienced the highest outflows among the 10 economies, with US$964.8 million withdrawn in the five trading days, followed by India funds, which lost US$740.9 million, and Singapore funds, which saw withdrawals of US$201.6 million."

However to just look at absolute numbers may be one-dimensional. We also have to look at withdrawals relative to market size, and the relative popularity of certain markets over the last 3 months in particular. Grouping those parameters, you will find that the impact is greatest for China, followed by Malaysia and then Singapore. In actual fact, Malaysia was the hottest market globally on a YTD basis, hence no surprise that Malaysia will lead in gains and correction quantums. What's significant was the US$4 billion redemption in a week is the largest ever weekly redemption, and more than 2.5x the next biggest redemption which was recorded in May 2006.

The fact that the all time biggest redemptions did not cause a major collapse in emerging markets indicate that there are a lot more investors at play, not just mutual funds. More players, better underlying quality and depth to the run.

Time to get nervous? Well, I would regard the above examples as indicators of a much stronger quality bull run. Having a redemption that is 2.5x bigger than the previous biggest amount, and still being able to withstand and see it turnaround, is a pretty big deal. The yen carry trade is big, but not everyone will act as one. They all entered at different times at differing currency levels and invests in different instruments. The absolute size may be growing and it cannot grow forever, but the recent scare would have prompted a significant amount to cover and unwind their positions - thus temporarily deflating the pent up risk-balloon.

If we were to look at global equities, the huge run-up in oil prices in 2005 and 2006 did not cause markets to collapse. In fact markets continued to defy the rising price of oil and gas. The jumps in fuel prices, to me, was even bigger in significance to the current yen carry trade fear. Rather than take all these as negatives, I see a much stronger base being built underneath the current bull run.

There is an additional factor now, the pricing in of risk. What that means is that when markets retest their all time highs (and they will this year), instead of thinking two or three times, investors will be thinking 5 or 6 times before plunging head first into the rally. Pricing in of risk will mean that at every significant level we will see more profit takers and doubters, it will mean a much more gradual climb and not the kind we have been seeing for the past few months.