ETF Investors Are Unbundling Emerging Markets

While ETF investors seem to dislike emerging markets, that doesn't mean they aren't investing in them.

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A market in an emerging market.

Photographer: Dhiraj Singh/Bloomberg

It turns out that exchange-traded funds that track emerging markets have experienced healthy inflows of investment over the past few years. They just hasn't come in the form we're used to. 

While recent focus has centered on big outflows from emerging market ETFs—$6 billion lost over the last three years to be exact–single-country ETFs that track emerging-markets nations have enjoyed $7 billion of inflows.

This indicates that at least some investors are breaking EM exposure into more targeted pieces as they, along with such people as Mohamed El-Erian, question the logic of grouping disparate countries like India, Russia, Mexico and Poland into one, catch-all pile.

That trend stands in contrast to international developed markets, in which regional ETFs are still preferred to single country ETFs. For example, regional European ETFs have taken in $42 billion over the last three years, while Europe's single-country ETFs have taken in just $8 billion. 

Josh Brown, chief executive officer of Ritholtz Wealth Management, suggests that the developed world is less disparate than the EM world is:

"There is no difference between Portugal and Spain. Portugal is like diet Spain. But, there’s a huge difference between Russia and India. One is a commodity exporter, one is an importer. Their demographic trends are racing in different directions. This is why I bet we smash the BRIC idea completely. The whole idea of EM/DM has very little to do with each other. We only own them in a packager because it is easy. But it is probably not the best way to invest."

Recent returns support this, too. The four BRIC countries (Brazil, Russia, India, and China) show nearly 100 percentage points of variation in return over the last three years. India is up 43 percent while Brazil is down 52 percent, for example. That is about five times more than the difference in return among the 10 largest countries in the Vanguard FTSE Europe ETF.

The wide-ranging characteristics and returns of developing countries are why some question whether "EM" should be an asset class. The table below shows exactly where the money has been going during the past three years, as well as the very different returns for each country.  

As one would expect, flows mostly followed returns.

Such was the case with India, which got a big boost from the election of a pro-business prime minister, Narendra Modi. On the flip side, investors yanked cash out of Brazil as the market slumped. Such countries as Russia bucked the trend while investors tried to call a bottom. All in all, $7 billion in new cash flowed into EM through single country ETFs while headlines were citing "massive outflows" from emerging market ETFs.

The downside to breaking up EM would be increased volatility and the prospect that one might pick "losers" with no "winners" to offset them. However, these numbers suggest that investors may be willing to stomach that risk in exchange for the ability to assemble their own emerging exposure, piece by piece.

Eric Balchunas is an exchange-traded-fund analyst at Bloomberg. This piece was edited by Bloomberg News.

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