BNY Mellon Extends iFlow to EM: Sees Strong China

BNY Mellon has extended its iFlow monitoring tool, which offers a near-real time look at real money portfolio flows across the world’s FX, fixed income, and equity markets, to emerging markets.

The bank has distributed a whitepaper, which it says demonstrates iFlow’s usefulness in capturing EM portfolio flows, which generally proxy official balance of payments (BoP) information. The whitepaper further estimates 2021 EM capital flows and offers analysis that indicates China will continue to attract portfolio investment at a strong pace, while other regions should see some mean reversion after declines in 2020.

The whitepaper observes that the growth in EM assets in investment portfolios has been “one of the most important secular trends in asset allocation over the past two decades”, adding that having recovered from multiple crises in the 1990s, emerging markets’ rising share of the global economy has been accompanied by a deepening of national asset markets, attracting a greater share of portfolio flows in the process.

“As the world’s largest custodian bank, we are in a prime position to capture these trends,” the paper states. “Using historical data from iFlow, we find that our custody flows in many emerging markets are strongly consistent with the trends captured in official BoP data. The share of total flows captured in iFlow varies between individual markets, but as we elaborate in this piece, in most cases it is sufficient to capture and potentially anticipate flow dynamics in a timely manner.”

BNY Mellon analysts suggest that iFlow and official data show most EM flows exhibit cyclical trends. As these economies are largely commodity- or manufacturing-focused, their balance of payments will be highly exposed to changes in global demand.

The analysts fit BoP data with iFlow data using regressions – country BoP data is represented as the net liability incurrences out of net portfolio flow in equities and bonds. The sample sets start in 2005 and extends to the end of 2020. For each quarter BNY Mellon calculates the ratio of a rolling 12-month iFlow aggregate for equities-plus-bonds against official flow figures over the same period. It then calculates the median of this ratio over the past 15 years. “We exclude from the calculation quarters where the flows implied by iFlow was opposite to that of the official BoP data,” the whitepaper states. “The ratio of iFlow data was the lowest in China at 7%, highest in India.”

Next, BNY Mellon runs simple regressions of BoP data on iFlow equity-plus-bond aggregates and says for Asia, all estimates show a positive relationship. “The strongest result is observed in China because recent flows have been abnormally large and iFlow data capture the structural trend higher, resulting in 0.6 R-squared,” the paper says. “The weakest results were for India and Korea, at 0.08 and 0.02 R-squared, respectively. In Korea, this is likely due to large demand for foreign assets as well as foreign demand for equities and bonds. In India, equity flows are usually less reliable than bond flows.”

China will continue to see strong capital inflows this year, while the rest of the EM complex catches up after a year of strong portfolio outflows in 2020

Finally, the paper estimates a flow projection using slope and intercept data – the input is the current 12-month rolling iFlow aggregate for equities and bonds. The output will be the fitted BoP data for equity-plus-bond rolling annual flow, the bank adds.

The analysis provides strong insight into emerging market portfolio flows, BNY Mellon says, adding that the whitepaper shows that for many EMs, the data is a useful proxy for cyclical trends in these countries’ official BoP data.

“In countries like China, which has enjoyed nearly uninterrupted growth in portfolio flows, iFlow manages to pick up these trends, while in markets in which we observe more cyclicality, peaks and troughs in iFlow match up well with the official data,” the paper says. “Our empirical work shows that for many markets iFlow captures the variation in the official BoP data. This property, along with the fact that iFlow data is reported much earlier than official data, has allowed us to project portfolio flows for 2021.

“Our projections imply that China will continue to see strong capital inflows this year, while the rest of the EM complex catches up after a year of strong portfolio outflows in 2020,” it concludes. “This mean reversion feature of capital flows is captured by looking at current levels of iFlow-implied flows, which are – except for China – quite low relative to historical measures.”