By Dodd Kittsley, CFA Global Head of ETP Research at BlackRock
According to the headlines last year, emerging market equities could do no wrong. With issues abounding in developed market economies and growth in the developing world on fire, these typically riskier stocks were tempting even the more conservative investors with their potential for out-performance.
Fast forward to now, and the story has changed rather drastically. With emerging market stocks hitting a 5-month low and significant outflows occurring in the biggest EM equity ETFs, at first glance it may seem as though investors are abandoning the category. But a closer look at ETF flows shows that many still agree with our long-term positive view of EM stocks [see also How To Pick The Right ETF Every Time].
In fact, the pattern of flows into and out of EM equity ETFs proves that investors are taking a more unique and varied approach to investing in the space. Here are three trends we saw in Q1 that show investor sentiment is still decidedly pro-emerging markets:
- Single countries. Q1 flows into the emerging market equity ETFs were split between funds that offer broad, diversified exposure (+$3.3bn) and single country ETFs (+$0.9bn). This represents a pretty sizeable pullback in the former category, but it also illustrates a significant increase in investors taking a more granular approach to emerging market investing. The standout country was Mexico (+$2.0bn), which could be the result of investor optimism over widespread reforms occurring in the country’s telecom, oil and education sectors.
- Minimum volatility. This relatively new category of ETFs has been a timely solution for investors trying to navigate the “new normal” of volatile markets. Minimum volatility ETFs generally give access to a particular area of the market (in this case, EM stocks) with fewer of the high highs and low lows that the market experiences. The iShares MSCI Emerging Markets Minimum Volatility ETF (EEMV, A+) is a great example, pulling in $910mn in Q1. But while investors may be discovering this category as a way to navigate current market volatility, they could end up sticking around for the potentially better risk-adjusted returns.
- All cap exposure. Many investors don’t realize that the MSCI Emerging Markets Index –the bellwether index for the EM space – only represents large- and mid-cap stocks. While this may be the exposure you’re looking for, there are several well-documented reasons to consider including small cap exposure – things like greater diversification and potentially higher returns. One of our newer ETFs, the iShares Core MSCI Emerging Markets ETF (IEMG, A), tracks an index that includes these small cap EM stocks and, with inflows of $691mn in Q1, is close to reaching “critical mass” status of $1bn in assets.
One interesting thing to note is that the outflows from (EEM, A-)(-$1437mn) were almost the same amount as the combined inflows into EEMV and IEMG. That said, we don’t believe that any of these trends are indicative of a long-term aversion to the bellwether emerging markets ETFs. When the tides turn in emerging markets, many investors will likely return to the large EM ETFs as an easy way to gain relatively liquid, diversified exposure. And, as our capital markets team often points out, many large ETFs like the iShares Emerging Markets ETF EEM, can have their own “ecosystem” in the trading world, where institutions and traders use them for a variety of strategies alongside other investment vehicles– even when broad EM equity exposure may be temporarily out of favor with individual investors.
I think the takeaway here is that there’s sometimes more to the investment story than the headlines suggest. While significant outflows in large emerging markets ETFs can make for a compelling article, it belies the flurry of activity that may be occurring below the surface in the newer or more granular ETFs. And as more ETFs with varied exposures continue to enter the market, the story will only get that much more complex. Which might be bad news for the news, but good news for investors.
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Source: BlackRock ETP Research, Bloomberg
In addition to the normal risks associated with investing, international investments may involve risk of capital loss from unfavorable fluctuation in currency values, from differences in generally accepted accounting principles or from economic or political instability in other nations. Emerging markets involve heightened risks related to the same factors as well as increased volatility and lower trading volume. Securities focusing on a single country may be subject to higher volatility.
Diversification may not protect against market risk. There can be no assurance that an active trading market for shares of an ETF will develop or be maintained. Past performance does not guarantee future results.