When investors all decide to stampede into the same asset, there's always the worry that the fast money in will be just as fast on the way out.
Investors have largely ignored this concern over the past few months and piled in developing-market bonds, especially those denominated in dollars. This debt has posted huge returns, dwarfing gains on U.S. government bonds and stocks. The nations benefiting the most have often been among the weakest, including Venezuela, Brazil and Sri Lanka.
But sentiment appears to be changing as markets fall globally.
The largest exchange-traded fund that focuses on this debt -- the iShares J.P. Morgan USD Emerging Markets Bond ETF -- just posted a record one-day withdrawal. That's a marked reversal for an ETF that has received more than $4 billion of deposits so far this year.
Some may dismiss this as a temporary, knee-jerk response. Investors may just be locking in this year's gains as markets become more tumultuous. Perhaps it'll start like that, with just some selling around the edges, but it's easy to see how these losses could spiral.
First, investors are waking up to the fact that central bankers worldwide are running out of ammunition to push bond yields lower, prompting investors to flee from all types of debt, from the lowest to the highest rated. Because emerging-market assets have been one of the biggest beneficiaries of the stimulus efforts, it makes sense for them to suffer the most as these programs lose steam.
Second, any selling of developing-nations debt will most likely punish valuations significantly, leading to losses that'll make bigger institutions consider withdrawing some cash as well. This is because funds are essentially fighting the calendar. Investors usually hold off from allocating to emerging markets in the last three months of the year, leading to much smaller inflows. In other words, this seasonal effect means there'll be a smaller cushion of money coming into these nations to offset the money flowing out.
The tide has started turning for developing nations. Investors are going to be more cautious going forward, and the highflying debt is going to suffer.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
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