Regulated Funds, Emerging Markets, and Financial Stability

Regulated fund holdings of emerging market stocks and bonds have grown significantly in the past decade. This growth is part of a broader trend of investors seeking greater exposure to emerging markets, and these flows have supported strong growth in emerging economies. From 2010 to 2014, emerging market economies received cumulative gross portfolio capital flows of $1.4 trillion. A small fraction of those inflows — less than $200 billion — came from regulated funds. New empirical results in this report suggest that there are three main reasons that regulated fund are unlikely to pose systemic risk to emerging markets. First, regulated fund holdings of emerging market securities remain a small portion of the total value of the stocks and bonds of emerging market countries. Second, while regulated funds represent a sizable part of the foreign investor base in emerging market countries, they are a stable investor base. Third, regulated fund holdings are diversified across a wide number of emerging economies, which limits the effects of their portfolio transactions on any particular country. In monthly data, returns on emerging market securities are explained by factors other than funds’ net purchases of emerging market stocks and bonds — most significantly by capital flows from other (non-fund) foreign investors. Also, in weekly data, regulated funds’ net purchases of emerging market securities do not drive returns. Weekly data show that while net purchases respond with a lag to returns on emerging market securities, those purchases do not have a persistent effect on future returns.