Scoffing At Fear: Embracing Emerging Markets ETFs

The Vanguard FTSE Emerging Markets ETF VWO and the iShares MSCI Emerging Markets ETF EEM, the two largest emerging markets ETFs by assets, are lighter by almost $9 billion in combined lost assets this year, but that does not mean investors should continue being scared of developing world equities.

While those two titans of emerging markets ETFs are still sporting year-to-date losses in excess of 15 percent apiece, the funds have recently rebounded. Since the start of September, EEM and VWO are up 7.2 percent and 6.4 percent, respectively. A large part of that performance differential can be attributed to South Korea.

As in EEM holds South Korean stocks and VWO does not due to how the ETFs' index providers classify Asia's fourth-largest economy. South Korea is the second-largest country weight in the MSCI Emerging Markets Index, EEM's underlying benchmark. The iShares MSCI South Korea Capped ETF EWY is up more than 16 percent since the start of September.

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"While investors are wary of some EM exposures, we have found there are pockets where investors are putting their money - both in basic broad funds along with specific countries. In October, flows stabilized along with the MSCI EM Index. Specifically, China H Shares funds are seeing inflows, as are other country funds in Asia. The reason behind this: confidence in foreign reserves and the potential for long-term economic reform," according to a recent BlackRock note.

Africa And Brazil

Confidence in foreign reserves usually comes with investors having confidence in a country's currency. With that in mind, it is not surprising that ETFs tracking emerging markets with weak currencies, such as the iShares MSCI South Africa ETF EZA and iShares MSCI Brazil Capped ETF EWZ, have been drubbed this year. EWZ has already endured a downgrade to Brazil's sovereign debt rating while market participants eye EZA as potentially suffering a similar fate.

There have been pockets of less bad/almost strength among emerging markets ETFs this year, including India funds. The $3.7 billion iShares MSCI India ETF INDA is up 5.1 percent since the start of September and its year-to-date loss is half that of broader emerging markets ETFs.

"India equity ETFs have average organic growth of 26 percent over the past three years. Prime Minister Modi's election last May and his ambitious plans for economic reform sparked strong inflows of $5.1 billion over the last 6 quarters. Sentiment has shifted a bit since July, however, as Modi's tax, land and labor proposals have inspired ETF redemptions of $1.3 billion in Q3 of this year, based on Bloomberg and BlackRock data. Still, inflows are net positive over the longer horizon," according to BlackRock.

Perhaps the strongest catalyst for India ETFs is the Reserve Bank of India (RBI), arguably the most effective central bank in the developing world. That effectiveness is borne out by the strength of India's currency, the rupee. The WisdomTree Indian Rupee Strategy Fund ICN is one of the best-performing emerging markets currency ETFs this year.