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The Great GEM ETF Takeover
By Alexander Redman |

Page 1 of 13

One of the most significant dynamics in emerging market equity assets under management over the past year (aside of course from the magnitude of redemptions during the market turmoil) has been the noticeable shift away from actively managed towards exchange traded funds.
Of the pool of US$365bn of emerging market equity assets tracked by Emerging Portfolio Fund Research in their weekly data set, over 30% is now passively managed within ETFs versus less than 16% in mid-February 2008.
In 2H2008 as regional emerging market actively managed funds in aggregate registered a brutal almost uninterrupted succession of weekly net outflows for a cumulative US$41.0bn, ETFs registered 18 out of 27 weeks with net inflows for a cumulative US$13.8bn over the same period.
Of the US$29.5bn total cumulative net inflows into emerging market regional equity funds year to date, some US$16.9bn (or 57%) has flowed into exchange traded funds. In the EMEA region the proportion of total equity assets under management within ETFs is significantly less than the other regions at just 14%, although the growth rate is by far the highest—up by 3.5 times since February last year when just 4.2% of equity AUM were in ETFs.
We would argue this is as a result of retail investor disillusionment with relatively high fees for actively managed portfolios on top of the losses they have booked over the past year, coupled with emerging market ETFs offering a cheap highly liquid source of beta for global cross-over investors without having to do their homework into individual stock selection.
Why is this important? Firstly, the vast majority of emerging market ETFs are aligned along regional or country geographies rather than by sector (in contrast to developed market ETFs which are predominantly sector oriented). This will serve to self reinforce the tendency for active funds to invest by country rather than by sector and may significantly increase intra-country stock correlations rendering country selection (a top down macro approach) increasingly as important as stock selection in emerging market investing. Secondly, the increased use of emerging market ETFs by global cross over investors as a convenient instrument to go long/short beta within their portfolios may serve to add emerging market equity volatility going forward.
One of our tactical indicators for pan-emerging market and EMEA regional equities is the percentage of weeks in the last ten with net inflows into retail funds. This metric has a reasonably tight historic association with the percentage deviation in the MSCI EMF index 10-week moving average.
For the past 3 weeks, pan-emerging market equity funds in aggregate have received net inflows for all previous 10 weeks. The only other occasion this decade with 10 out of 10 weeks of net inflows was the week to 7 November 07. Associated with a decade record in our fund flow indicator is a record positive deviation in the MSCI EMF above its 10-week moving average.
We’d caution that typically from these levels inflows and price momentum undergo a strong reversal. Notably, the position for EMEA regional funds does not appear as stretched with seven out of the past 10 weeks with net inflows.

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