This article first appeared in Capital, The Edge Malaysia Weekly on September 21, 2020 - September 27, 2020

FOREIGN funds have been flowing out of equities in emerging markets such as Malaysia in search of higher returns in more developed markets. And there has been no sign of net inflows. Why is this the case?

Although the FBM KLCI performed relatively better than its peers in the region since the March lows, foreign funds have been net sellers of Malaysian equities over the past 14 months. The local benchmark index has declined 4.8% year to date.

While glove stocks have brought handsome profits for investors, analysts say this is not enough to attract foreign funds.

For the first eight months of the year, net foreign outflows amounted to RM20.3 billion, although foreign selling was reduced to RM1.5 billion in August from RM2.6 billion in July. Consequently, foreign ownership of Malaysian equities dropped to a record low of 20.8% of the FBM KLCI’s total market capitalisation in August from 21.1% in July, according to UOB Research.

The overall capital market saw an inflow of foreign funds for the third month — of RM1.5 billion — as government debt sales outweighed equity market sell-offs. It is worth noting that foreign investors turned net buyers in the local market to the tune of RM70.91 million for the week ended Sept 11.

In explaining why foreigners are shunning the local bourse, MIDF Amanah Investment Bank Bhd research head Imran Yassin Yusof tells The Edge that foreign funds are attracted to the rally in big technology stocks in the US. “In the Covid-19 world, tech stocks will benefit the most,” he says.

The five best-performing US technology stocks are Facebook, Amazon, Apple, Netflix and Alphabet (the parent of Google), better known as the FAANG stocks. Apple has been a star performer, with its market value swelling to US$2.15 trillion (RM8.9 trillion).

Rakuten Trade head of research Kenny Yee points out that technology companies in the local market are mainly small-cap stocks, which do not attract many foreign funds. He says foreign funds are unlikely to be net buyers of equities anytime soon, unless there is a rebound in corporate earnings. “By then, we may see foreign funds accumulating banking, plantation and telco stocks.”

Yee says foreign shareholding in local stocks could fall even lower, judging from the selling trend. “But the quantum of selling could be less because foreign shareholding is already at the very bottom. They have been underweighting Malaysia for quite some time. When things improve, they will come back to the equity market.”

He notes that the strong liquidity in developed markets is another key factor causing the foreign fund outflows from emerging markets. In Malaysia, he says, foreign funds usually invest in key component stocks such as banking counters, but their performance has been weak since the Covid-19 outbreak. “This year, most of the banks are seeing negative growth. That is why foreign funds are not interested yet.”

MIDF’s Imran Yassin agrees, saying that foreign funds typically invest in value stocks that are tied closely to the economy. Note that Malaysia’s economy shrank 17.1% in 2Q2020, owing to the impact of Covid-19 and the Movement Control Order.

An analyst who declines to be named says not just Malaysia but the whole region has been seeing foreign fund outflows. “I don’t think the trend will reverse. Foreign funds need a lot of big-cap stocks. They already have some local big-cap counters in their portfolios, so maybe there are not many stocks for them to buy anymore,” he says.

He adds that the most important factor is the attractiveness of the local market as a whole. “We need to have strong economic growth and corporate earnings.”

Since the March lows, the local bourse has been supported mainly by retail investors and local institutions. Glove stocks have been the star performers, supported partly by the participation of foreign funds.

“The fundamentals of glove counters will still be there, as the production of a vaccine remains unknown. There continues to be foreign investor interest in glove stocks,” says Imran Yassin.

Currently, Top Glove Corp Bhd and Hartalega Holdings Bhd are the only glove stocks on the FBM KLCI. Kossan Rubber Industries Bhd and Supermax Corp Bhd could be included in the benchmark if their share prices remain elevated at the next review in November. Earlier this month, Kossan and Supermax were added as constituents of the MSCI Global Standard Indices whereas IJM Corp Bhd was dropped.

Imran Yassin highlights that during economic shocks, developed markets have fewer currency and sovereignty risks than emerging markets. “Developed market currencies are more stable. So, you don’t have much volatility, and it is safer.

“It is more of a risk-off mode for investors. Next year, when things get better, the risk-return tradeoff could be much better in emerging markets than in developed markets.”

While political stability is another consideration for foreign funds, Imran Yassin is not too concerned about that after seeing a change in government twice. “Whichever party wins, the overall policy and operations of the government will still continue. It seems that people can accept a change in government,” he says.

Meanwhile, former Inter-Pacific Securities head of research Pong Teng Siew highlights that the US dollar weakness has helped boost the US economy’s competitiveness, which explains why the US stock markets remain attractive. In contrast, the economic outlook does not look as promising for emerging markets, which are heavily dependent on exports and global trade.

“Even with the supply chain reshuffling in the electronics sector, it is not advantageous for emerging markets, especially when US President Donald Trump is emphasising ‘Made in America’,” says Pong.

On another note, foreign investors remained net buyers of Malaysia’s debt securities at RM3 billion for the fourth consecutive month in August, lower than the RM7.1 billion in the preceding month. With that, the total foreign holding of debt securities edged up to RM209 billion, the highest level since March 2018. Its share to Malaysia’s overall debt increased to a seven-month high of 13.3%.

Kenanga Research says in a Sept 8 note that the country’s relative success in combating the Covid-19 pandemic, coupled with the broad US dollar weakness, has spurred the interest of investors hunting for higher yields in Malaysian treasury bonds.

The average yield of the 10-year US Treasury bonds inched higher slightly by four basis points (bps) to 0.66% in August, as new debt issuance — coupled with upbeat US economic data — weighed on trading, pushing prices lower and driving yields higher.

The average yield of the 10-year Malaysian Government Securities (MGS) fell 13bps to a record low of 2.51% in August, narrowing the average yield spread to 186bps.

In view of the strong ringgit, Imran Yassin expects foreigners to remain net buyers of Malaysian bonds until year-end. “Once economic recovery is more certain, however, you will see a switch to equities,” he says.

Another analyst says MGS are much more attractive now in terms of their risk profile, as they are backed by the government.

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