Fund Flows Hint At Frothy Emerging Market ETFs

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Includes: EEM, PXH, SPEM, VWO
by: Carl T. Delfeld

Emerging markets have snapped back sharply since their pullback in August and their run over the past few years has been spectacular. For example, the Shanghai Composite index has increased sixfold during the past six years.

One has to ask, are markets way ahead of themselves? Has the rebound been too far too fast with broad-based emerging market ETFs like (NYSEARCA:EEM), which is up 30% since just mid-August?

One of the five areas that Chartwell ETF evaluates in making ETF portfolio decisions is fund flow data from EPFR Global. EPFR Global provides fund flows and asset allocation data to financial institutions around the world. Tracking both traditional and alternative funds domiciled globally with $10 trillion in total assets, we deliver a complete picture of institutional and individual investor flows and fund manager allocations driving global markets. Our market moving data services include daily, weekly and monthly equity and fixed income fund flows and monthly fund allocations by country, sector and security.

EPFR Global data shows that for the third week in a row Emerging Market Equity Funds including ETFs absorbed over $5 billion as investors continue to bail out of underperforming developed market asset classes and head for either cash, emerging markets or, to a lesser extend, commodities such as gold. Since the fourth week of August investors have parked $23.9 billion in emerging markets funds, $28.1 billion in Money Market Funds and $895 million in Commodity Sector Funds. During that same period they have pulled $6.85 billion out of Europe Equity Funds, $6.26 billion out of US Equity Funds and ETFs, $4.1 billion out of Global Bond Funds and $3.87 billion out of Japan Equity Funds and ETFs. Within the emerging markets fund groups it was again Asia ex-Japan Equity Funds that took in the most cash during the second week of October.

“Investors and institutional sources of capital appear to agree with leading equity strategists who think the liquidity injected into global markets by the Fed’s September rate cut will benefit emerging markets, which have the winning combination of sounder fiscal balances, faster growth and proven outperformance,” says EPFR Global Managing Director Brad Durham. “But the strength of the flows and the speed of the re-rating of emerging market equities over the past three weeks is somewhat troubling.”

“Recent performance and flow numbers look like they are outstripping fundamentals,” says EPFR Global Analyst Cameron Brandt. “During the last big run, between October 06 and February 07, it took 20 weeks for the funds we track to gain around 23%. That run ended with $9.5 billion flowing out over two weeks and 7% being shaved off year-to-date performance

In addition, emerging markets and the exchange-traded funds that track them may be vulnerable to the impact of the sub-prime problems according to a leader in emerging market investments.

“The biggest worry now is the psychological impact – and I emphasise psychological impact – of subprime,” Mr Mobius told FT.com in the website’s inaugural “View from the Markets” weekly video interview.

“I think a lot of people are focused on that and maybe have over-emphasised the impact of subprime.

“There’s no clear evidence that consumer spending is slowing down in America ... But now that it’s so much in the news it may have an impact on people’s propensity to invest. And so that could be a problem.”

Nevertheless, he said, some US investors were realizing anew the value of diversification into developing countries. “[They] see emerging market currencies getting stronger against the US dollar, they see economies growing at a much faster pace – stronger than the US or Japan.”