Emerging ETFs Turn Positive for 2014 as Outflows Reversed

Emerging-market exchange-traded funds are officially back in favor.

Flows into the funds turned positive for the year yesterday, by $109 million, reversing investor flight that had drained as much as $13.9 billion in the first 2 1/2 months of the year amid financial crises in Ukraine, Argentina and Turkey.

Now, money managers are being lured back into developing-nation ETFs by optimism that new leaders in India, Indonesia and potentially Brazil will take measures to bolster flagging economic growth. BlackRock Inc. has attracted about $2 billion into its developing-nation products this year, the most among fund providers.

Emerging markets have been growing in popularity in the past few months,” Adam Laird, a passive investment manager at Hargreaves Lansdown Plc, said by phone from Bristol in the U.K. “We’ve seen flows into broad products because nobody is 100 percent sure where the growth is going to lie, but they know that the emerging economies are likely to see it.”

While conflicts in Ukraine and the Middle East have intensified, U.S.-based ETFs that invest in emerging markets had inflows of $645 million this week on demand for higher-yielding assets and speculation new administrations led by Narendra Modi in India and Joko Widodo in Indonesia will promote growth. Fixed-income products received about $1.4 billion this year, offsetting $1.2 billion of outflows from their equity-based counterparts and $79 million of redemptions from currency funds.

Bleeding Money

After bleeding $9 billion through March 21, BlackRock’s $42 billion iShares MSCI Emerging Markets ETF, the seventh-largest exchange-traded product in the world, lured back $8.4 billion through July 23 as the Federal Reserve maintained its guidance on the timing of the first interest-rate increase in 2015.

The MSCI Emerging Markets Index gained 7.8 percent this year through yesterday, getting a boost from signs that the Chinese economy will avoid a hard landing. A gauge of manufacturing in the biggest emerging market rose to an 18-month high in July.

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“The combination of stronger U.S. Treasuries and a more stable China than many feared has supported the entire EM complex,” Arko Sen, a strategist at Bank of America Corp. in London, said by phone. “The major risk is geopolitics. There are concerns about Russia and the Middle East. There are still risks out there for emerging markets, and more recently we have seen them taking more attention.”

Higher Valuations

The MSCI emerging-markets index slipped 0.2 percent at 10:40 a.m. in New York, paring this week’s gain to 1.5 percent.

The relative strength index of the BlackRock ETF rose to 66 this week, approaching the 70 threshold that to some technical analysts signals a security is overbought. MSCI’s developing-nation stock benchmark trades at 11.2 times projected earnings, the highest level since 2011, data compiled by Bloomberg show.

Investors have pulled $62 million from the Market Vectors Russia ETF (RSX), the biggest U.S. exchange-traded fund that holds Russian shares, since the crash of Malaysian Airlines Flight 17, which the U.S. and European Union say may have been downed by a Russian-made missile system. All 298 passengers and crew aboard the plane were killed.

Brazil-focused exchange-traded funds have also reported outflows this year as the economy slipped into stagflation under President Dilma Rousseff’s watch.

China Flows

Investors have withdrawn $513 million from the Latin American nation’s ETFs. Inflation in the first half of July breached the ceiling of the official target range of 2.5 percent to 6.5 percent. Economists surveyed by the central bank have cut their 2014 growth forecasts for eight straight weeks.

And flows into China ETFs have failed to bounce back. Investors have withdrawn $1.5 billion from China-targeted exchange-traded products amid concern over economic imbalances in the Asian nation. Premier Li Keqiang is working to safeguard economic growth while also trying to cool an overheating property market and restrain combined government, corporate and consumer debt that exceeded 206 percent of gross domestic product as of June 30.

The Shanghai Composite Index has lost 0.5 percent this year, the worst performance among major developing markets in Asia monitored by Bloomberg. That compares with an 8.6 percent gain in the MSCI EM Asia Index.

Mobius Bullish

Mark Mobius, the executive chairman of Templeton Emerging Markets Group, predicts Chinese shares will rally, saying in an interview yesterday he’s favoring state-owned banks and energy companies because of their cheap valuations and the government’s plans to open up state-dominated industries.

The Fed’s lower-rates-for-longer policy has contributed to an increase in the attraction of higher-yielding, emerging-market assets. Ten-year interest rates in the U.S. and Germany at 2.5 percent and 1.18 percent, respectively, on July 24 compare with 8.65 percent for India and 8.05 percent in Indonesia.

India-focused ETFs have recorded inflows of $1.5 billion this year, more than any other country, as the S&P BSE Sensex Index surged to a record, while funds targeting Indonesia have attracted $123 million on optimismWidodo will replicate nationally the success he had as Jakarta governor in cutting red tape and boosting investment.

Mexico funds have attracted in $136 million on bets President Enrique Pena Nieto’s efforts to push legislation aimed at boosting economic expansion will fuel earnings growth.

“Five or six months ago we had hardly any exposure, now emerging markets probably make up around 25 percent of our portfolios,” Irene Bauer, chief investment officer at Twenty20 Investments, a London-based firm that specializes in ETFs, said by e-mail on July 24. “The macro economic data has improved for quite a few of the emerging-market countries. India and China, in particular, have good outlooks.”

To contact the reporters on this story: Ash Kumar in London at akumar314@bloomberg.net; Boris Korby in New York at bkorby1@bloomberg.net

To contact the editors responsible for this story: Daliah Merzaban at dmerzaban@bloomberg.net; Nikolaj Gammeltoft at ngammeltoft@bloomberg.net Stephen Kirkland, Nikolaj Gammeltoft

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