Inflows: Emerging market bulls keep on partying
Investors who recognized the upside potential in emerging market equities in early 2016 are likely already in the “hangover stage” of celebrating sizable YTD (year-to-date) returns. iShares’ MSCI Emerging Markets ETF (EEM), for instance, is up ~16.4% this year, outperforming benchmark equity index ETFs in other major regions of the world.
In the United States, SPDR’s S&P 500 ETF Trust (SPY) is looking at a YTD gain of ~7.2% while iShares’ MSCI EAFE ETF (EFA), which focuses on developed markets excluding the United States, is barely breaking even. Yield-hungry investors who didn’t invest in emerging market equities during the first half of 2016 are now playing catch-up. A look at last week’s country ETF inflows illustrates the urgency to allocate assets into the emerging market equity space.
Demand for emerging market ETFs rises
As you can see in the chart above, five of the ten ETFs with the largest weekly inflows in our country universe focus on the emerging market equity space. The well-known EEM clearly ranked first, as investors poured ~$1.3 billion of capital into the ETF. Importantly, these inflows pushed cumulative net inflows for EEM to a YTD high. At the same time, EEM locked in a fifth consecutive week of gains, rallying ~2.4% last week.
To fully demonstrate the increasing breadth of capital flows into EEM, note that you can find four additional emerging market–focused ETFs among last week’s top ten country ETF inflows:
Reasons for the continued inflows into emerging market equities
First, consider that EEM witnessed outflows during the three years prior to 2016 while its performance was negative as well. EEM only started to turn around at the beginning of 2016. A large majority of investors was hesitant to allocate capital into emerging market equities, fearing a sell-off similar to the well-known “Taper Tanturm,” especially after the US Fed raised rates in December 2015. As US Treasury yields didn’t rise but started to move sharply lower, initial fears decreased.
Plus, investors have come to accept the economic and political risks inherent in emerging market countries in exchange for yields that can’t be found in developed markets.
Outflows: Currency-hedged ETFs still out of favor
Turning our attention to last week’s top ten country ETF outflows, we note that investors continued to take money out of currency-hedged ETFs. The largest outflows were registered in WisdomTree’s Japan Hedged Equity Fund (DXJ) and the Deutsche X-trackers MSCI EAFE Hedged Equity ETF (DBEF). In fact, DXJ and DBEF’s outflows made up ~60% of the top ten country ETF outflows. You can see the relative magnitude of these outflows in the chart below.
Last week’s outflows in DXJ reflect a much broader story that developed in 2016. In fact, the currency-hedged ETFs has seen YTD (year-to-date) outflows of ~$5.3 billion—the third-largest outflows within our entire ETF universe. This trend largely resulted from a strengthening Japanese yen (lower USD/JPY) as investors started to bet against the effectiveness of Abenomics. At the same time, the Tokyo Stock Exchange Tokyo Price Index (TPX) plummeted ~14.9% since the beginning of 2016. A stronger yen against the US dollar—coupled with plummeting Japanese equities—is a toxic combination for DXJ, which provides exposure for investors who would like to bet on the exact opposite scenario.