Country Flows: Is Europe Riskier than Emerging Markets? 3
FRANKFURT, GERMANY - AUG 23: The Famous Big Euro Sign at the European Central Bank on August 23, 2012 in Frankfurt, Germany. The bank was established by the Treaty of Amsterdam in 1998.

Inflows: Emerging market yields are worth the risk

The iShares MSCI Emerging Markets ETF (EEM) clearly attracted the largest capital inflows last week. The recently volatile ETF attracted ~$1.2 billion in cash and locked in a weekly gain of ~0.8%. You can see the relative magnitude of EEM’s inflows in the chart below.

emerging markets

One of the reasons for the improving optimism toward emerging market equities is the Federal Reserve’s hesitation to raise interest rates. Last week, Fed chair Janet Yellen sounded dovish in a testimony before lawmakers. She said the Fed is watching for “whether” the US economy shows clear signs of improvement. Federal fund futures imply a mere ~45% probability of a rate hike by the end of this year.

From a yield perspective, investors can squeeze out more gains from emerging market debt. Bonds in countries like Brazil (EWZ) or Turkey (TUR) are in especially high demand. For this reason—and also because of receding global economic fears—EEM now trades well above its recent lows. From a fund flow perspective, the ETF now ranks among the top 10 ETFs in terms of inflows on a year-to-date basis.

Outflows: It just doesn’t look good for Europe

Looking at last week‘s largest country ETF outflows, we find that European-focused ETFs dominated the picture, as the chart below shows.

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emerging markets

We already pointed out the big capital flight from Vanguard’s FTSE Europe ETF (VGK) in Part 3 of this series. Looking at country ETF outflows in isolation underscores investors’ anxiety toward Europe. The chart above shows that six out of the ten country ETFs with the largest outflows last week focus on Europe. Even ETFs with relatively little or no exposure to the United Kingdom—such as the iShares MSCI Eurozone ETF (EZU) or the WisdomTree’s Europe Hedged Equity Fund (HEDJ)—fell out of favor. The broader capital outflows from Europe show that investors are concerned not only with the United Kingdom but also with the pace of Europe’s economy.

Last week’s ETF flows illustrate the importance of making selective investment choices. Carefully picking a well-structured ETF can have a significant impact on portfolio returns. Whether risk sentiment remains positive or not, it may be wise to become pickier when allocating capital.  

This article was written by Meikel Mokry, a research analyst at Market Realist.


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