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Emerging-Market Funds Are Not the Problem

NEW YORK (TheStreet) -- Financial Times writer John Authers took a unique stance on emerging markets investing through exchange-traded funds.

Authers notes that the current selloff in emerging markets has been conducted mostly through ETFs. He cites a statistic from Morgan Stanley (MS) that ETFs account for roughly 25% of the entire market cap of emerging-market equities. However, refutes that number, saying there is $117 billion in emerging-market ETFs.

Authers appears to believe that the ease of trading these markets through ETFs has made them more volatile because it has overwhelmed the volume that these markets would otherwise need to accommodate.

He goes on to say that sentiment of developed market investors should not have such a disproportionately large effect on emerging markets, that investing in this space should be about patience.

There are several instances where Authers misses the mark in his analysis, however. The article as written gives the impression this selloff is a very recent event caused by frenzied ETF trading. In fact, the iShares MSCI Emerging Markets ETF (EEM) has lagged behind the SPDR S&P 500 (SPY) three years in a row. EEM hit its all-time high in April 2011 and arguably has been in a downtrend since that high.

One way to look at the trading of the last couple of months is that it has been a selling climax in the context of a shallow bear market -- EEM is down 24% from that high of three years ago.

Authers may also be underestimating the impact of the Federal Reserve's asset purchase reduction, the so-called tapering. The general idea is that certain emerging markets that are very dependent on foreign direct investment will see that inflow decrease once investors can again achieve satisfactory yields through simpler holdings in the U.S. bond market. Tapering is viewed as the first step to yield normalization.

it is crucial to remember that the various policies enacted by the Fed and the U.S. Treasury to combat the Great Recession were unprecedented but were the types of things that, according to economics textbooks, should have had extremely negative consequences. Buying debt in the manner the Fed has done it should be inflationary, should undermine the U.S. dollar and send yields rocketing higher while sending people fleeing to precious metals. But, of course, that has not played out in asset prices.

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