Add this to the list of worries.
Mutual funds and ETFs have been piling on the emerging market debt ever since the Federal Reserve launched their zero interest rate policy.
The surprise devaluation of the yuan is leaving a gaping question: Will mutual funds bolt from their investments, much of it dollar denominated?
In a story Sunday in The New York Times, the paper notes:
EPFR Global, a fund-tracking company, calculates that global bond funds have allocated 16 percent of their holdings to emerging-market bonds. Relative to the 2.5 percent recommended benchmark for these securities suggested by the Barclays aggregate bond index, that is a very aggressive bet.
Some big name funds are at risk, the Times reports, including BlackRock, Franklin Templeton and Pimco, which has 21% of assets, or $101 billion, in EM bonds and derivatives. Unconstrained bond funds, which invest regularly in the EM world, have exploded. Morninstar reports they’ve grown to $154 billion from $9 billion in 2009. Pimco’s unconstrained fund has 42% of its $7.9 billion in EM bonds, mostly Brazilian debt.
Bond investors have been whining about how little liquidity there is the general bond market — bid/ask spreads are appreciably wider than they were pre-crisis. But those are minor inconveniences compared to what could happen if all the major investors rush to the exits to dump their dollar-denominated or even local currency EM debt. Can anyone spell d-e-s-e-r-t-?