Investors Gravitate to Emerging Markets Funds

Emerging markets funds (including both mutual funds and ETFs) suffered net outflows of $395 million for the fund-flows week ended Wednesday, May 2, 2018. However, this was the first weekly net outflow for the peer group during 2018, breaking a streak of 18 consecutive weekly net inflows. Emerging markets funds took in $19.9 billion of net new money for Q1 2018, which was their second largest quarterly net-positive flow ever, trailing only the $20.8 billion for Q3 2010. The group has taken in net new money for six straight quarters now (including Q2 to date) to grow its coffers by almost $65 billion. The $41-billion annual net inflow for 2017 was the group’s third largest annual net inflow ever.

There is a negative correlation between the movement of the dollar and investor sentiment toward emerging markets funds. Emerging markets assets are risky, and one of the factors that contributes to this risk is the cost related to servicing emerging markets’ U.S. dollar-denominated debt. Therefore, as the U.S. dollar appreciates against a local emerging market currency the debt service costs rise and make a risky asset even more risky. Emerging markets funds have benefitted from a decline in the U.S. dollar that started at the end of 2016. Since then through the end of Q1 2018 the value of the trade-weighted U.S. dollar index (which measures the value of the U.S. dollar relative to a weighted average of the currencies of the United States’ major trading partners) fell from 95.72 to 86.27. The index continued to fall in Q2 before rallying to close April at 87.50. The rally in the dollar was a definite contributor to this past week’s net outflows for emerging markets funds.

The positive net flows for the group for the year to date (+$23.7 billion) have been relatively evenly split between ETFs (+$14.4 billion) and mutual funds (+$9.3 billion). The largest individual net-positive flows have belonged to iShares Core MSCI Emerging Markets ETF (IEMG, +$7.9 billion), iShares MSCI Emerging Markets ETF (EEM, +$2.5 billion), and mutual fund American Funds New World Fund (+$1.6 billion). The net inflows of the peer group have been heavily concentrated, with the ten largest (of a total of just over 300 funds) accounting for 72.0% of the total positive flows.