Money Flows or "Hot Money" data sets can be an enhancing factor in any country tactical allocation system. However, backtesting suggests its usefulness is mainly limited to GEM (Global Emerging Markets) or DM (Developed Markets) with huge GEM influence. Macro factors are expecially important when screening GEM stocks, for which reason country risk is significantly higher for GEM stocks than DM stocks. Hence, a deep understanding upon which countries should we go long or short when screening candidates in the vast GEM space is a key step. The APAC region (Asia EM + Japan + Australia) has been used to build such a country allocation scoring model. Country-specific money inflows for this region should be important due to the Emerging Markets bias inherent in the region. High correlation between Emerging Asian countries Starting by considering broad indices annual returns for each country as well as annual inflows/outflows over a period of 9 years (2004-2012). Several interesting insights by looking at the correlation matrix below: Correlation Matrix: Flows (Green) / Returns (Blue)
Are Inflows a good predictor of market returns in Asia Pacific? We conduct further analysis on country indices returns against equity capital flows. We found out that the probability of obtaining an inflow and positive return on the same year is higher in Asia than in the rest of the world: the average probability for Asian countries is around 85.9% whereas it is only of 71.1% in Europe and 33% in USA. High Probability at seeing positive inflows and returns at once Another study to be tested was the probability of obtaining an inflow the year following a positive return and the probability of obtaining a positive return the year following an inflow. We reached the same conclusion: Asian indices returns are more dependent on inflows than rest of the world indices. On the other hand, we haven't witnessed a clear pattern between flows and forward returns, meaning price momentum in the region does not attract inflows when considering a one year lag. Flows tracking returns probability has been substantially lower Inflows loose significance when considering a 1 year time lag To go further into in our analysis, we performed the following regression: rt = α + β rt-1+ γFt+ δFt-1+ ε where rt is the index return on year t and Ft is the country inflow on year t. This model is a simple preliminary one that gave us very good results with high R2, proving once again that inflows drive market returns in Asia. China set aside, the model explains more than 70% of the indices returns variations. R^2 coefficients are quite significant explaining returns Of course, there's a small size bias in our sample (annual frequency observations from 2004 to 2012) so it would be interesting to run our model using quarterly or monthly data. Expanding the time span will deliver flawed results since the majority of the countries have changed structurally over the last five or ten years, for which reason a more frequent data should avoid spurious results. Conclusion: A Flow Scoring Factor adds value to screening, risk management and portfolio management The first intuition that inflows drive market returns in Asia is confirmed. The user can apply this conclusion to multiple ends within equity screening, portfolio management or risk management. For instance, a scoring model where countries are ranked using probability-weighted YTD equity capital flows is to be an interesting tool for GEM-focused portfolios. Therefore, YTD Net Inflow percentage over each country AuM and the a priori probability that each local stock market reacts to those capital inflows or outflows are to be key inputs in the construction of a country allocation factor. Disclaimer: the blog is intended to convey investment ideas and, market views , yet they are not a solicitation or recommendation to buy/sell/hold securities but merely investment ideas that should NEVER serve as the basis of the reader trading decisions. This website and its reports are for general information purposes and any investment decision should be discussed with a financial adviser before taking place. The investment ideas displayed here could have been implemented at an earlier date than the one stated at the blog's post date; for which reason the latter dates do not represent accurate and timely entry/exit points in order to protect those investors with whom the blog author has a fiduciary agreement.
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Carlos Salas
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