Recently the emerging markets (China, Brazil, Turkey, etc.) have seen an economic downturn. This downturn is caused by a variety of circumstances including the European market downturn, devaluation of currencies, and an overall slowdown in manufacturing. However, this downturn has not yet changed the investment strategies of a variety of mutual funds. This is worrisome considering the lack of liquidity or ability to sell interests in the current economic environment.
The International Monetary Fund, or IMF, warned on Tuesday September 30th that the large position of a variety of mutual funds in the United States in high yielding bonds has raised red flags in emerging markets. Many mutual funds hold large positions in hard to trade securities markets, and they are usually able to sell off these positions quickly but this report cautions that there may not be enough liquidity in the market as previously thought. This evaporating liquidity is especially concerning considering that nearly $100 billion has been pulled from global bond and equity markets this year by U.S. investors. This removal of money from the emerging markets makes the positions the mutual funds are taking even more worrisome.
This report adds more concern about emerging markets such as China and Brazil. China has had a rough month both due to the devaluation of the Yuan, the decrease in commodities production, and slump of the Chinese economy. Brazil has undergone a massive downturn primarily due to the scandal surrounding Petrobras. The concerns of the IMF echo a more general concern of regulators and economists that investing the mutual funds with high risk and high yield securities rewards in emerging markets will be difficult to offload if the market takes areversal.
The IMFs report specifically addressed the large amount of cash being moved around and the heightened central bank activity of the past years, which may, in their view, give an impression of the ability to offload assets whenever they may need to. The effect is the seeming endless liquidity in the market but as the report stated, “[e]ven seemingly plentiful market liquidity can suddenly evaporate and lead to systemic financial disruptions.” Adding to the liquidity problem many large investment banks do not trade in these securities due to the risk these securities pose.
Adding to the risk is the increase in bonds issued by large emerging market corporations. These bonds are still being picked up by mutual funds in the United States. Bonds issued in dollars have been the fastest growing subsection of corporate debt.
This warning comes on the heels of the Securities and Exchange Commission proposing new regulations concerning new regulations concerning mutual and exchange-traded funds. These new regulations should assist with the current problem facing the investments in emerging markets.
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