Not only are emerging markets equities and exchange-traded funds (ETFs) surging this year, those assets are sharply outperforming U.S. stocks while offering better value. The combination of those factors is prompting investors to allocate new assets to emerging markets ETFs in a big way.
Year to date, the widely followed MSCI Emerging Markets Index is up 18.9 percent, an advantage of 400 basis points over the MSCI EAFE Index and double the returns of the S&P 500. This year's top 10 asset-gathering ETFs include two emerging markets equity funds and one emerging markets bond fund. Only one ETF has added more new assets this year than the $10.1 billion added by the iShares MSCI Core Emerging Markets ETF (IEMG). (See also: Investors Love This Emerging Markets ETF.)
Investors are clearly responding to resurgent emerging markets assets. The good news is that, while international ETFs, particularly emerging markets and Europe funds, are increasingly popular with investors, that does not mean that these trades are dangerously crowded. In fact, some market observers believe that allocations to international equities are not at alarming levels and that ex-U.S. developed and emerging markets continue to offer upside potential.
"EM and European stocks are no longer the contrarian trades that they were for much of 2016, but we believe there's still a strong case for exposure to international stocks," said BlackRock, Inc. (BLK) in a recent note. "Our 'risk ratio' gauge of risk appetite is at levels consistent with moderate risk taking, but nowhere near the 'irrational exuberance' seen in the late-1990s or mid-2000s. Strong inflows year to date have only replaced a quarter of the outflows from EM stocks between the 2013 Taper Tantrum selloff and mid-2016, and only 17 percent of the flows out of European equities last year." (See also: Catalysts Abound for Europe ETFs.)
IEMG, one of the least expensive emerging markets ETFs, is up 18.7 percent year to date after jumping 10.3 percent last year. Last year was the first time that IEMG notched a positive annual performance since 2012, when the ETF debuted in the fourth quarter. "We view crowding as a sign of heightened risk rather than a signal to sell," said BlackRock. "There have been significant flows into exchange-traded products and mutual funds across asset classes this year, as perceived economic and political risks have declined and many investors have put cash to work in response."
IEMG allocates a combined 54 percent of its weight to China, South Korea and Taiwan. The three largest ETFs tracking those countries are up an average of 20.7 percent this year, but on a net basis, combined inflows to those three funds are just $263.5 million. That could be a point in favor of the notion that the emerging markets trade is not yet overcrowded. (See also: Where the Bulls Run Fastest: Emerging Stock Markets.)