Emerging market ETFs captured big inflows last week in a sign investors are becoming increasingly bullish about the prospects for the asset class.

According to data from Ultumus, the $5.6bn UBS ETF MSCI Emerging Markets UCITS ETF (EMMUSA) saw $753m inflows in the week to 22 January, the most across all European-listed ETFs.

Following this, investors poured $102m into the $1.3bn Xtrackers MSCI Emerging Markets ESG UCITS ETF (XZEM) over the same period highlighting the positive investor sentiment as coronavirus vaccines get rolled out across the globe.

The popularity of emerging market ETFs appears justified by the strong outperformance relative to the S&P 500 amid a Joe Biden presidency and inflationary pressures on developed market assets pushing momentum back in their favour.

Highlighting this, the Vanguard FTSE Emerging Markets UCITS ETF (VFEM) is up 7.1% so far this year while the Vanguard S&P 500 UCITS ETF (VUSA) has returned just 3.4% over the same period.

Likewise, over the past three months, VFEM has outperformed VUSA by 6.6%, as at 27 January.

Without a doubt, a key factor in this recent momentum has been Joe Biden’s election victory, which will bring, what BlackRock described as, more accommodative foreign policy.

After four years of tariff rollouts by former President Donald Trump, emerging markets have enjoyed a burst of excitement as investors price in the return of a more traditional foreign policy approach. 

Another factor playing into the popularity of emerging markets is the reaction to the news that the five-year forward inflation expectation in the US now stands above 2%. With investors having adjusted to a low-inflation and low-interest environment over the past decade – and in turn, bought into long-dated assets such as bonds and growth equities – what we are now seeing is a shift back to cyclical equities.

As Russ Mould, investment director at AJ Bell, said: “This apparent return to form for emerging markets coincides with a period of strength for commodity prices and dollar weakness. Whether it lasts may hinge to a great degree on those two trends, which also tie into the inflation narrative.

“If those three continue to coincide, then we could see a third major period of emerging market outperformance relative to the USA (and by implication developed markets), to match those of 1988-1994 and then 2000-2010, so this EM resurgence must be monitored closely. If it proves to be no mere flash in the pan, then it could have profound portfolio implications.”

Can emerging markets continue their resurgence as ETF investors pile in?

A further consideration supporting the emerging market investment case is that the asset class may be better positioned than developed markets for the pandemic recovery. So far, Korea and Taiwan have rebounded as global export activity began to recover in recent months. Looking ahead, there is hope that Hong Kong and Thailand will also benefit from a return to relative normality, as tourism and business travel recover in the medium-to-long-term.

Also, it is worth noting that from a public health perspective, Asian emerging market constituents may be more likely to bounce back from the pandemic than their developed, Western counterparts. Recent emerging market outperformance may be a partial expression of the view that Asia was the first region to be afflicted by COVID-19 and is, therefore, more likely to overcome the virus before Western countries.

“Given the experience of SARS in 2002-03, Asia may have been better prepared and equipped to deal with such a situation. In addition, Asian nations learned harsh lessons about debt during their currency crisis of 1997-98 and as a result, aggregate government borrowing levels are generally much lower as a percentage of GDP than they are in the West.” Mould added.  

“This gives greater room for fiscal manoeuvre to support growth, should it be needed, and a potentially a firmer footing for currencies.” 

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