Emerging Market ETFs Buck Flows Trend

Not all emerging market funds are following the hot-money crowd to the exits.

Investors are yanking money out of emerging market funds left and right, prompting comments from the likes of Mark Mobius and Matt Hougan.

Yet amid this downturn—our MSCI benchmark for the space is down about 10 percent for the past 12 months—investors have quietly and consistently put significant money into a handful of broad emerging markets ETFs.

What gives? Even two funds from the same issuer that track practically identical indexes are telling different tales regarding net flows.

The iShares Core MSCI Emerging Markets ETF (IEMG | B-98) enjoyed $3 billion in net inflows over the past 12 months. It tracks a more comprehensive version of the index that underlies the hugely popular iShares MSCI Emerging Markets ETF (EEM | B-100), which suffered $15 billion in net outflows for the same period.

The most obvious explanation for the divergence in investor sentiment is cost. IEMG, part of iShares’ “Core” suite unveiled in October 2012, has an annual expense ratio of 18 basis points, or $18 for each $10,000 invested, compared with EEM’s 69 basis points. That’s a hefty savings, although EEM has the clear edge on trading costs.

In fact, EEM’s phenomenal liquidity itself may be the real key to understanding the difference in flows. I’d argue simply that EEM is the hot-money vehicle used by hedge funds and institutions to rush in and out of emerging markets as short-term conditions dictate. Check out this screen grab from our website ETF.com showing net flows for EEM:

In contrast, IEMG is marketed—correctly, in my view—as a long-term core allocation.

The underlying index, while similar to EEM’s, reaches deeper into the small-cap space. This makes it more reflective of the real market, which is a benefit for long-term exposure. The trade-off is that it’s a bit harder to trade.

IEMG’s assets are “sticky” because investors are here for the long haul. I’d guess that advisors and RIAs buy IEMG on behalf of their clients and then encourage their clients to stay the course, through what so far has been a tolerable correction. Some advisors with the fortitude may even be buying on the dip. The ETF.com fund flows tool shows nothing but inflows over the past 12 months for IEMG:

Maybe I’m wrong and IEMG’s inflows can be chalked up to BlackRock’s national ad campaign for its “Core” ETF lineup, or to its distribution muscle.

Yet these factors don’t apply to another large emerging market fund that’s seen solid inflows lately. The EGShares Emerging Markets Consumer ETF (ECON | C49) saw roughly $500 million in new investor money over the past 12 months.

ECON focuses on the consumer sectors of emerging markets rather than the financial and extraction-based industries that often dominate the developing world’s capital markets. ECON’s assets are sticky rather than fleeting, suggesting that investors are betting on the long-term growth in the middle class of the developing world, not on the short-term tweaks of the Federal Reserve’s monetary policy.

A low-volatility take on emerging markets, the iShares MSCI Emerging Markets Minimum Volatility ETF (EEMV |B-64), as well as a small-cap dividend play, the WisdomTree Emerging Markets SmallCap Dividend (DGS | D-71) have also seen new money come in. That’s $1.2 billion for iShares’ EEMV and $592 million for WisdomTree’s DGS over the same 12-month period.

Will long-term EM investors be punished or rewarded for riding out the storm? Behavioral finance suggests that doing the opposite—selling on the dip—tends to lead to bad outcomes and contributes to the gap between investor returns and investment returns.

Aside from this, what should we take away from the difference in where investors are putting money in rather than taking it out?

Fund flows aren’t great predictors of performance. The returns for the products I’ve noted here with positive flows have suffered along with EEM and VWO, the Vanguard FTSE Emerging Markets ETF (VWO | C-89). And sometimes ETFs “create to short-sell,” which simultaneously swells assets under management while also reflecting pessimism rather than optimism.

Still, fund flows, especially in a down market, can highlight the true nature of the fund you’re in, particularly whether it’s geared toward daily trading or long-term exposure.

Robust daily liquidity is no doubt essential for any ETF, but if I can get that with a sticky asset base too, so much the better. When investing for the long haul, I like to be there with like-minded folks.

At the time this article was written, the author held no positions in the securities mentioned. Contact Paul Britt at [email protected].