As more investors utilize exchange traded funds and other fund products to access developing economies, emerging market stocks have become increasingly volatile.
According to the Bank of International Settlements, the presence of asset managers in emerging markets had grown “considerably” and that “the concentrated use of benchmarks and the directional co-movement of investor flows can generate correlated investment patterns that may create one-sided markets and exacerbate price fluctuations,” reports John Authers for Financial Times.
Moreover, BIS economist point to evidence over the past two years that reveal “investor flows to asset managers and [emerging market] asset prices have reinforced each other’s movements.”
The “fragile five” economies with high current account deficits, which include Brazil, India, Indonesia, Turkey and South Africa, stand out in the emerging market space, experiencing broad swings due to investor sentiment.
Fragile-five emerging market ETFs, including iShares MSCI Brazil Capped ETF (EWZ) , iShares MSCI Indonesia ETF (EIDO) , WisdomTree India Earnings Fund (EPI) , iShares MSCI South Africa ETF (EZA) and iShares MSCI Turkey ETF (TUR) , all experienced heavy selling pressure as their currencies quickly depreciated on Fed speculation.
The five markets plunged on the Federal Reserve’s tapering talk in May of 2013, and from then until February 2014, the group’s total underperformance of emerging markets was 21.1%. After Janet Yellen was sworn in as the Fed’s chairwoman, the fragile five outperformed the broader emerging markets by 21.3%.
The wild oscillations are seen as excessive and BIS economists argue that the broad swings reveal the greater hand institutions and ETFs have on the emerging markets, as opposed to developed equities.
For instance, EM bond funds’ assets under management have quadrupled to $340 billion in the four years ended 2013. According to BIS, 1 percentage point reallocation of assets by the largest 500 managers, which manage a combined $70 trillion, could affect $700 billion in asset flows across the emerging markets. In comparison, the emerging markets saw $246 billion in outflows over the 2008 crash and $368 billion in inflows over 2012.
Additionally, BIS discovered that due to the dearth of broad emerging market benchmarks relative to developed markets, those that exist tend to correlated with one another. The iShares MSCI Emerging Markets ETF (EEM) , which tracks the MSCI EM Index, is up 6.4% year-to-date and Vanguard FTSE Emerging Markets ETF (VWO) , which tracks a FTSE EM Index, is up 9.8% so far this year. [Emerging Markets ETFs are Hauling in Plenty of Cash]