“Herd behaviour” fuelling risk in emerging markets, says BIS

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Rapidly growing emerging market funds and clustered investor flows are creating “vulnerabilities” in the developing world, according to a report released yesterday by the Bank for International Settlements.

The way the industry is managed, [with] widespread benchmarking and short-term performance assessment, limits the degree to which individual portfolio managers can deviate from industry averages,” said Hyun Shin, Economic Adviser & Head of Research at BIS. The report found that investors in the region tend to mirror each other’s behaviours, amplifying each other’s fluctuations in the process and creating a risk of unstable “one-sided markets.”

Data quoted by the BIS shows that emerging market bond funds soared from $88bn to $340bn between 2009 and 2013, whilst EM equity funds grew from $702bn to $1.1tn over the same period.

The behaviour of the ultimate investors can introduce further correlation,” Shin continued. “There is some evidence that during last year’s taper tantrum retail investors were prone to herding and they herded procyclically, which means they withdrew from funds when prices were falling and re-entered when they were rising, forcing funds to sell when prices were falling and buy when prices were rising.”

The BIS warned that regulators need to design an effective policy response to mitigate the effects of these behaviours to avoid volatility. At present, says the bank, regulation of the asset management industry is focussed too narrowly on  microprudential and consumer protection issues.

Data quoted by the BIS shows that emerging market bond funds soared from $88bn to $340bn between 2009 and 2013, whilst EM equity funds grew from $702bn to $1.1tn over the same period.

 

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