Lower inflation, structural reforms and improving trade balances is encouraging investors to put more money into emerging markets equities and debt, according to a new report from HSBC.
Dr Murat Ulgen, Global Head of Emerging Markets Research at HSBC, expects net capital inflows from non-residents to rise to $920 billion in 2017, and then to $1 trillion in 2018. Non-resident inflows into emerging markets hit a 12-year low in 2015 and then rose to $720 billion in 2016.
Meanwhile emerging markets residents are sending less money out of their home markets. The Institute of International Finance (IIF) said in June that it expected resident capital outflows would be $892 billion in 2017, a $141 billion decline from 2016. Much of that fall is down to tighter capital controls in China.
Given this background, perhaps it's not a surprise that emerging markets stocks have done well this year. We can compare the performance of the MSCI Emerging Markets index with the FTSE 100 and the US S&P by looking at three leading ETFs from iShares:
ETFYTD Performance Fund sizeIshares Core MSCI Emerging Markets UCITS (LSE:EMIM)+19.4%$7.05 billionIshares Core S&P 500 UCITS (LSE:CSP1)+3.3%$22.8 billioniShares Core FTSE 100 UCITS (LSE:ISF)+7.3%$6.6 billion
Even after these gains, valuations seem reasonable. Emerging markets are trading on a forward price/earnings ratio of 12.6, according to Lazard, and we're seeing decent earnings growth as well - 13% in June. Lazard argues that growth is being driven by better management as well as strong growth in the EM tech sector.
Nonetheless even though valuations don't seem stretched, and even though plenty of money is flowing in, global investors are still arguably underweight in emerging markets. Dan Tubbs of Mirabaud Asset Management told FTAdvisor that global investors are about 4% underweight with emerging market equities only comprising 12% of the MSCI World index.
We should also stress that emerging market equities are not a one-way bet. If we did see a correction or crash in developed market equities, emerging markets probably wouldn't be immune. What's more, there are real concerns about debt levels in China and political instability in several countries. And even though the link between emerging market equities and commodity prices does appear to be weakening, it hasn't gone away completely.
If you want to find out more about investing in emerging markets via ETFs, read our guide to Investing in emerging markets equities.