Emerging markets could produce next boom-bust cycle
As regulators clamp down on securitised products, leveraged investors are racing to new markets. JP Morgan analysts say the crisis might be shifting leverage from structured products to emerging markets.
As CDOs lose their lustre, leverage has moved on - and might have found its new home in the emerging markets.
“It is quite likely that, as one boom bursts under the weight of leverage, risk capital moves to the asset class where the memory of the last blow-up has receded the most,” said two JP Morgan analysts, Jan Loeys and Margaret Cannella, in a note released earlier this month. The last time there was a major bust in emerging markets investments was in the late 1980s and early 1990s, when there was broad-based default on bank loans to emerging sovereigns. “One might think it is the time for emerging markets to produce the next boom-bust cycle.”
Market participants confirm the emerging markets boom. “In the past few years emerging markets have seen a remarkable growth in assets under management,” said Alia Yousuf, the head of emerging markets at Standard Asset Management in London. But she admits the size of the market relative to other assets is small.
Phil Poole, the emerging markets chief economist at HSBC in London, agrees. “What has also happened is that there has been a portfolio reallocation, where we see money coming out of developed markets institutional investors, and it is not just leverage. We have seen Japanese investors, retail and institutional, diversify and emerging markets have been some of the beneficiaries of that,” he said.
Emerging markets experienced a record $780 billion fund net private capital inflow last year, a 37.3 % increase from $568 billion in 2006, according to figures released by the Washington DC–based Institute of International Finance (IIF). The largest beneficiaries of this inflow were emerging Europe ($365.2 billion) and emerging Asia ($249.8 billion).
In 2008 the boom has slowed. The emerging markets have not been immune to the US subprime-related difficulties. “Risk appetite has clearly dropped following the problems in the credit markets in the west. We are moving from a situation where everything was going right for the emerging markets to where investors are getting all cautious,” said Julian Jessop, the chief international economist at London macroeconomics consultancy Capital Economics.
But, he said, despite this, these markets have held up well. IIF forecasts a drop of only 6.28% in net fund inflows into the markets in 2008, which is a small amount compared with the 90% drop in CDO new issuance from $165 billion in the first quarter of last year to a meagre $16.7 billion in the comparable period this year.
With such a high level of interest, some fear that the level of leverage could spiral out of control, and quickly bring on another bust. Booms usually start with strong positive fundamentals that are taken to their extreme through momentum and leverage.
Some believe the level of leverage might already be at increased levels. “I don’t think it is fair to say that it is about to happen - I think it would be fair to say that in a sense it has already happened,” said Poole. “There has already been a lot of leveraged money that has been inside emerging markets- in carry trade and currencies and some of the credit and equity markets as well – so part of it has already been driven up by leverage,”
However, Loeys and Cannella argue leverage levels and asset prices are still too low to suggest a crisis: “The signs of an imminent emerging market crisis are not in place,” they said.
Jessop agrees. “I doubt that emerging markets are going to reach the high levels of leverage that structured products had reached,” he said. “I think people have learnt their lessons. Certainly among the banks there will be no appetite for taking on the level of risks they have done in credit markets.”
The IIF estimates that, of the total fund inflows into these markets in 2008, only 27.8% is expected to come from commercial banks. “Maybe some hedge funds might not feel so constrained. But then hedge funds are always looking for new areas to lose money,” Jessop said.
Even if emerging markets are spared, Loeys and Cannella concluded, the next bubble is inevitable: “The history of the past 30 years of liberalised capital markets does show that we eventually do again commit the sins of leverage and overconfidence and produce the next boom-bust cycle”.
See also : Basel Committee to tighten up rules after crisis
New derivatives disclosures will be “significant burden”
Isda AGM: CDS boom continues
Only users who have a paid subscription or are part of a corporate subscription are able to print or copy content.
To access these options, along with all other subscription benefits, please contact info@risk.net or view our subscription options here: http://subscriptions.risk.net/subscribe
You are currently unable to print this content. Please contact info@risk.net to find out more.
You are currently unable to copy this content. Please contact info@risk.net to find out more.
Copyright Infopro Digital Limited. All rights reserved.
As outlined in our terms and conditions, https://www.infopro-digital.com/terms-and-conditions/subscriptions/ (point 2.4), printing is limited to a single copy.
If you would like to purchase additional rights please email info@risk.net
Copyright Infopro Digital Limited. All rights reserved.
You may share this content using our article tools. As outlined in our terms and conditions, https://www.infopro-digital.com/terms-and-conditions/subscriptions/ (clause 2.4), an Authorised User may only make one copy of the materials for their own personal use. You must also comply with the restrictions in clause 2.5.
If you would like to purchase additional rights please email info@risk.net
More on Structured products
A guide to home equity investments: the untapped real estate asset class
This report covers the investment opportunity in untapped home equity and the growth of HEIs, and outlines why the current macroeconomic environment presents a unique inflection point for credit-oriented investors to invest in HEIs
Podcast: Claudio Albanese on how bad models survive
Darwin’s theory of natural selection could help quants detect flawed models and strategies
Range accruals under spotlight as Taiwan prepares for FRTB
Taiwanese banks review viability of products offering options on long-dated rates
Structured products gain favour among Chinese enterprises
The Chinese government’s flagship national strategy for the advancement of regional connectivity – the Belt and Road Initiative – continues to encourage the outward expansion of Chinese state-owned enterprises (SOEs). Here, Guotai Junan International…
Structured notes – Transforming risk into opportunities
Global markets have experienced a period of extreme volatility in response to acute concerns over the economic impact of the Covid‑19 pandemic. Numerix explores what this means for traders, issuers, risk managers and investors as the structured products…
Structured products – Transforming risk into opportunities
The structured product market is one of the most dynamic and complex of all, offering a multitude of benefits to investors. But increased regulation, intense competition and heightened volatility have become the new normal in financial markets, creating…
Increased adoption and innovation are driving the structured products market
To help better understand the challenges and opportunities a range of firms face when operating in this business, the current trends and future of structured products, and how the digital evolution is impacting the market, Numerix’s Ilja Faerman, senior…
Structured products – The ART of risk transfer
Exploring the risk thrown up by autocallables has created a new family of structured products, offering diversification to investors while allowing their manufacturers room to extend their portfolios, writes Manvir Nijhar, co-head of equities and equity…