Emerging markets exchange traded funds (ETFs) have raked in about $26 billion so far this year, which has sparked concern that all this hot money is feeding a growing asset bubble. But is this so?
Some fear that this so-called “mindless money” is being thrown at these markets, distorting valuations and pumping up a potentially monstrous bubble. (Find out how bubbles form and how to avoid them). Several markets, such as Brazil and Peru, are up 100% this year.
Jason Zweig for The Wall Street Journal reports that as money pours into the ETFs, they must mechanically match their holdings to those in the emerging-market indexes. That forced buying drives up stock prices, attracting still more new money into the ETFs, spiraling stock prices even higher.
One issue is that holdings in emerging market ETFs might be too concentrated and not fully reflect the real economy. For example, the manager of iShares MSCI Brazil (NYSEArca: EWZ) notes that Brazil’s market has been top-heavy for years. Two big companies dominate the market.
Even if these assets have led to distortion, ETFs may soon become forced sellers anyway, Zweig notes. Tax rules state that ETFs can’t allow their assets to become over-concentrated in a handful of holdings. In general, they can’t keep more than 25% of their money in a single stock, and at least half of their assets must be in securities that each account for no more than 5% of total holdings.
As a result, the inflows emerging market funds have seen lately could compel some of the largest ETFs to begin selling holdings to come in under the 25% limit. (Why emerging markets should be represented in your portfolio).
For more stories about emerging markets, visit our emerging markets category.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.