Equity funds investing in broad emerging market indices saw $845 million in net outflows for the week ended June 30, as investors anticipated the
Federal Reserve Board's
decision to raise interest rates by 25 basis points.
But investors did not shun emerging markets altogether, according to EmergingPortfolio.com, a Cambridge, Mass., company that tracks worldwide fund flows. Specialty investors continued to seek out opportunities in Indian equity funds, which had net inflows of $75 million during the period.
"Emerging markets are seen as highly cyclical," said Brad Durham, managing director of fund research at EmergingPortfolio.com. "When the Fed starts raising rates, there's a general belief -- which has been borne out in previous business cycles, that emerging markets start to underperform."
The benchmark MSCI Emerging Markets Index is down 2.44% for the year to date, having lost 1% in June alone, according to Morgan Stanley Capital International.
Although India's stock market is down about 17% for the year, Durham said investors are taking a longer-term view and have invested $1.25 billion into India funds as of June 30.
In the U.S., the
Morgan Stanley India Investment Fund and the
India Fund run by the Oppenheimer Asset Management subsidiary Advantage Advisers are two of the best-known routes to exposure in that market, he said. Another open-end fund offering is the
Easton Vance Greater India A fund, which has a 3.35% expense ratio.
Durham said Emerging Europe funds, which have an average 40% weighting in Russian stocks, have been among the best performers with net inflows of $1.3 billion year to date. The MSCI Eastern European Index is up 6% so far this year.
Bond investors also pulled $37 million from emerging market debt funds, mirroring the trend with U.S. bond funds, which generated net outflows of $1.3 billion in the most recent week, according to domestic fund tracker TrimTabs.
Durham said the ninth consecutive week of bond fund outflows brought net withdrawals to nearly $1.1 billion for the year to date.
"You had rapidly rising U.S. Treasury yields, and when emerging market investors and the crossover-type investors saw that rise so dramatically on expectation of monetary tightening, the money started flowing out," he said.
But emerging debt market fundamentals have never been better, with nine of the ten largest debt markets now rated at investment grade, Durham said. Although smaller outflows continued last week, the market has stabilized since the huge selloff in May, which was responsible for much of the net outflow for the year.
"The notion that emerging markets are this highly volatile basket case that you dip into occasionally to get a little extra spice in your portfolio is kind of changing," he said. "The fact that they've stabilized in the last month is an indication that people who were just leveraging those markets are out of the system, and that investors are now turning to fundamentals."