Deutsche Bank AG (DB, Financial) released its latest fund flows last week, revealing numerous surprises. According to the investment bank's latest fund data, investors continue to increase their exposure to long-term bonds and emerging market equities, while sectorial preference remains balanced. In light of the newly released data, I decided to communicate my thoughts on recent investor behavior.
Without further ado, let's traverse into the analysis.
Overview of broad-based exposure
As illustrated by the diagram below, U.S. government bonds experienced a significant inflow in the week ending on Aug. 9. However, the asset class' fund flows remain volatile for the time being. On the other end of the spectrum, riskier assets such as high-yield bonds, developed market equity and emerging market bonds remain underappreciated by investors in today's market environment.
A surprising fact about Deutsche Bank's recent fund flows is the significant influx into emerging market equities, which I will elaborate on later. Investors are bypassing most risky assets, including emerging market bonds, and entering emerging market equities, which is a strange occurrence.
Source: Deutsche Bank; James Wong
Detailing the increased exposure to long-term bonds
I mentioned before that, although volatile, Deutsche Bank's U.S. government bond funds have experienced significant inflows in the past few weeks.
Further analysis shows investors favor long-dated bond funds. In fact, short-term bond fund flows are in a steady net decline, communicating that investors are playing the longer end of the yield curve.
Source: Deutsche Bank; James Wong
The inflow into long-dated bonds is not a surprise as the term premium has receded in recent months, which in isolation provides a base case for higher valuations. In my view, the term premium will continue to trend lower in the coming quarters as inflation, market volatility and liquidity risk abates, concurrently providing support to long-term bonds instead of shorter-term credit.
Source: St. Louis Fed
Understanding the emerging market stocks influx
Investors usually opt for emerging market stocks during the early stages of an economic recovery, characterized by a steep yield curve, low credit spreads and favorable manufacturing data. According to my knowledge, these variables have not aligned, nor have other risky assets such as corporate debt and emerging bonds performed well; thus, seeing the rising demand for emerging market equities is strange.
Source: Deutsche Bank; James Wong
A deeper dive into Deutsche Bank's stock fund flows shows that emerging market equities flows are concentrated. The diagram at the bottom of this section illustrates that ex-Japan Asia is adding a significant drag on investor liquidity, presumably due to the region's low-interest rate environment coupled with oversold stock opportunities. Moreover, although retreating in its latest recorded week, Latin American inflows are robust on average amid regional interest rate cuts paired with compelling gross domestic product trend growth.
Source: Market Trends
The Latin American-Asia tradeoff
The recently experienced tradeoff between ex-Japan Asia and Latin America is unsurprising as the two markets possess a low pairwise correlation. To illustrate the abovementioned claim, I plotted the correlation coefficients between regional exchange-traded funds, including BlackRock Inc.'s (BLK, Financial) iShares MSCI China ETF (MCHI, Financial) and MSCI Brazil ETF (EWZ, Financial), among others.
Based on the correlation matrix, the markets possess a correlation of merely 0.483, implying frequent deviations in trajectory.
Source: Author's work; data from Portfolio Visualizer
In my opinion, Latin America possesses better long-term prospects than ex-Japan Asia as regional GDP trend growth is high. However, ex-Japan Asia is entering its interest rate cut cycle, which might lend cyclical opportunities to regional stocks.
Observing the balanced sectorial bets
Deutsche Bank's sectorial fund inflows suggest no noticeable conviction from investors as funds have flowed into cyclical, countercyclical and non-cyclical industries in the past weeks.
For instance, telecommunication stocks are popular; however, industrial stocks have also gained traction in the same period.
Source: Deutsche Bank; James Wong
A balanced inflow into sectors usually indicates that investors with a sectorial investment approach are unsure about the economy's prospects. I base this on the notion that non-cyclical stocks tend to outperform the broader stock market in a contractionary environment while the opposite occurs in an economic recovery. As such, sector-based investors are likely playing a game of wait-and-see.
Final thoughts on the fund flows
Although challenging to depict, Deutsche Bank's latest fund flows data provides valuable insights into investor sentiment.
A receding term premium has resulted in favorable allocation toward the longer end of the yield curve, suggesting contemporaneous support for long-dated Treasury bonds. Furthermore, ex-Japan Asian equities are popular among fund investors, while other risky assets such as corporate debt and emerging market bonds continue to struggle, suggesting significant tactical bets.
Lastly, sector-based fund flows are diversified with no conviction communicated, implying that investors are playing a game of wait-and-see.
Even though the current market environment is difficult to frame, it is clear lucrative investment opportunities are at bay.
