Exchange-traded funds that invest in emerging market equities are going through a rough patch as the dollar climbs higher and rising interest rates stoke fear of global recession.
Overall, investors pulled out more than $260 million on Monday from emerging market ETFs, according to FactSet. One of the more popular ETFs, the BlackRock -managed iShares Core MSCI Emerging Markets ETF (ticker: IMEG), fell below $60 billion in net asset value for the first time since late 2020 on Monday. Investors pulled out $640 million last week, the largest weekly net outflow since April 2020, according to Dow Jones Market Data.
Much of the pain comes from the strengthening dollar, which has gotten a boost from the Federal Reserve’s interest rate hikes. The U.S. Dollar Index reached its highest value for the year on Tuesday. The strong dollar has increased the cost of dollar-denominated debt in other countries, including on company balance sheets.
And the central bank has signaled further rate hikes are in the cards. That, combined with the historic slump in the British pounds and geopolitical risks such as lockdowns in China and Brazil’s election, is heightening global uncertainty and hitting emerging markets.
“The reason you would [typically] stay in emerging markets is for diversification,” Dave Nadig, a financial futurist at data provider VettaFi told Barron’s. But investing with that reasoning now “is like picking up pennies in front of steam rollers.”
Emerging market-focused funds have had a rough year. Among Morningstar’s list of 91 diversified emerging market ETFs, The Next Frontier Internet & Ecommerce ETF (FMQQ) has performed the worst this year, down 50%. It is weighed heavily in South Korea and Brazil. Invesco’s S&P Emerging Markets Low Volatility ETF (EELV), down 11% this year, is holding up the best. Half of its portfolio consists of companies in Taiwan and Thailand.
Where emerging markets go from here is a tough guess for strategists. Jeremy Schwartz, global chief investment officer at WisdomTree Asset Management, says China’s 20th Party Congress on October 16 could lift emerging markets. If President Xi were to signal an easing of the country’s Covid policies at the event, it could help support the market.
But there are a lot of other factors that need to change before emerging markets return, Schwartz said, highlighting tensions in Taiwan, as well as rate hikes in the U.S., which he said are more aggressive than necessary.
This might be an attractive entry point for investors who believe in the long-term potential of a developing market, Jason Blackwell, chief investment strategist at $19 billion wealth management firm The Colony Group, said. It is not impossible to assume that today is the bottom in emerging markets, Nadig said.
Only time will tell.
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