Capital flows have traditionally focused on the ‘demand side’ of emerging market financing by examining current account balances, which are equal to the net external financing needs of countries, and then seeking to identify ways in which these financing needs could be met and on what terms. However, this approach ignores trends in capital flows into and out of the major advanced economies, which are the source of most cross-border capital and the main reason why gross flows have risen so dramatically relative to net flows. These flows are typically in a securitized form and, as such, are susceptible to trading in active secondary markets. By one estimate, investors in the mature markets of Europe, the United States and Japan have been accumulating securities issued outside their own countries at the rate of about US$1 trillion a year (Smith 2000). This means that international capital flows are increasingly determined by global asset-allocation decisions made by globally active financial institutions in major industrialized countries. These institutions are becoming increasingly concentrated as a result of the global trend toward consolidation. Understanding capital movements increasingly requires an analysis and understanding of the underlying investor base.
A case in point relates to the on-off nature of the market for emerging market dollar denominated bonds. The dedicated investor base for emerging market securities has contracted in recent years, reflecting the closure of several large hedge funds, the orientation of other hedge funds toward mature market investments and reductions in the capital allocated to support the activities of the proprietary trading desks of some international investment banks.… Read the rest