Emerging market equities are back in fashion

emerging shoots 410Emerging market equity funds accounted for nearly half the $8.6 billion (€6.5 billion) of net inflows absorbed by equity funds in the week ending 25 January, says data provider EPFR.

The result could hint at a turnaround in demand for such funds, which had a disastrous year in 2011 in terms of flows. According to EPFR's end-of-year figures, $48 billion flowed out of emerging market equity funds in 2011.

These funds have suffered from the perception that emerging market equities are a risky asset. Because of this reputation, emerging market equities have been subject to periodic selloffs over the past year.

However, emerging market equity funds had a good year in 2010, when they attracted nearly $100 billion of new money, according to EPRF.

Among the most popular emerging market funds in the week ending 25 January were Asia ex-Japan equity funds, which hit a 30-week high in terms of inflows, and India equity funds, which hit a 54-week high. Meanwhile, Latin America equity funds had their best week since 2010.

EPFR said growing confidence that China will experience a soft rather than hard landing helped boost demand for emerging market funds, particularly Asian funds.

Proponents of emerging market investing say global growth trends will guarantee that emerging market equities will generate strong returns in the coming years. The emerging markets account for roughly half of the world's economic activity, have much stronger GDP growth than the developed economies, and have a lower debt burden.

However, GDP growth does not always translate into stock market returns. Ted Pulling is a fund manager at JP Morgan Asset Management, focusing on Asia. He admits that 2011 was a disappointing year for investors in Asia and warns that the first half of 2012 will be “tricky”. But he believes the long-term outlook is positive.

“The three key things that may provide support to Asian markets are: waning inflation, an improvement in earnings, and supportive valuations,” he said. “We are coming to the end of the tightening cycle in Asia.”

In other emerging markets such as Latin America and Russia, a key factor will be whether European politicians find a resolution to the eurozone crisis, as this problem has the potential to introduce significant volatility into the global economic system.

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