ETFs haven't been immune to the market's downtrend.
Investors are pulling their money out of emerging market ETFs at the highest rates since 2008. Here are three things you need to know about emerging market ETFs before making your move.
Fed Rate Hikes Add Debt to Emerging Markets
It's normal for emerging markets to experience sell-offs near the end of the business cycle, but the scale of recent losses are singling other factors are at play, according to Henderson Capital Group founder and chief investment officer Carter Henderson.
"The 'smart-money' will move away from the emerging markets and into safer investments when we're near the end of a bull market - I believe we are seeing this signal right now," Henderson said. "Furthermore, when the Federal Reserve raises interest rates it puts a lot of added pressure on the emerging markets. Rising interest rates in the U.S. make it more expensive for emerging market countries and businesses to take out dollar denominated loans. Also it becomes more expensive for those countries to pay back their dollar denominated loans."
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For this reason, Henderson is advising his clients to "limit their exposure to emerging markets ETFs or avoid them all together."
Trade Tensions Threaten Growth
Rate increases aren't the only U.S. policy wreaking havoc on emerging markets, according to Henderson.
"The trade war that the U.S. is ensuing on multiple countries is adding certain stress to the emerging markets ETFs, especially China," Henderson said. "China's stock market has fallen 20% from its recent highs this year and this is the worst start for the Chinese market since 2010."
Consistent growth in the U.S. and a strong dollar are also problems for emerging markets says Komson Silapachai, Vice President at Sage Advisory.
"Emerging markets came under fire due to a perfect storm of events, not only is the Fed continuing to hike rates, U.S. economic data continued to get stronger while data in Europe and some emerging countries went to the downside," Silapachai said. "Throw in trade tensions and the result is a stronger dollar and higher funding costs for emerging market entities, which negatively affected emerging market equities and fixed income."
Big Losses, Time for Big Returns?
Despite recent losses and fears that more are to come, emerging market ETFs may be a good investment for risk takers who have time to wait for big gains, Associate Vice President of Global Multi-Assets at USAA Asset Management Lance Humphrey said.
"We believe this may be an opportunity for investors who are underweight emerging markets to add to their positions," Humphrey said. "We believe the recent headlines have led to an undue sell-off in emerging markets, particularly on a relative to basis to the United States."
Investors wanting to take advantage of steep returns from small-cap stocks might be wise to channel their earnings into emerging market ETFs, Humphrey said.
"We believe this presents an opportunity for investors to re-balance their winning small-cap stocks into more beaten down emerging market names," Humphrey explained. "This combination we believe can help overcome some of the recent negative headlines and offer long-term, patient investors an attractive opportunity."