Areas of Potential Weakness in Emerging Market ETFs

With China’s spending on the decline and the U.S. Federal Reserve aiming toward tighter monetary policies, emerging market exchange traded funds that track the so-called fragile five – Brazil, India, Indonesia, South Africa and Turkey – could mirror the weakness experienced earlier this year.

“Growth in emerging markets has been driven by Chinese demand and easy global liquidity, but both of these are now under pressure,” Maarten-Jan Bakkum, strategist, emerging markets equity at ING Investment Management, said in a Financial Times article.

When the market environment converged on similar circumstances in early 2014, fragile-five emerging market ETFs, including iShares MSCI Brazil Capped ETF (NYSEArca: EWZ), iShares MSCI Indonesia ETF (NYSEArca: EIDO), WisdomTree India Earnings Fund (NYSEArca: EPI), iShares MSCI South Africa ETF (NYSEArca: EZA) and iShares MSCI Turkey ETF (NYSEArca: TUR), all experienced heavy selling pressure as their currencies quickly depreciated.

Investors may be dialing back their emerging market exposure in anticipation of risks ahead. For instance, the Institute of International Finance statistics calculates that inflows to EM assets declined to $9 billion in August, down from a monthly average of $38 billion between May and July.

Specifically, the IIF statistics reveal outflow from emerging Europe and Africa, along with a sharp decline in inflows to emerging Asia and Latin America.

“The sharp slowdown in portfolio flows in August could mark the beginning of a period of greater caution among global investors toward EMs,” Charles Collyns, the IIF’s chief economist, said in the article, adding that a “cyclical turning point” may have been crossed.