Emerging Market ETFs Yet to Catch Up With Sell-Off

Jacob Harper  |

In June 2012, emerging bond market ETFs started to experience a major sell-off. This sell-off was triggered by weakening growth outlooks at the market, and a more general shifting away from emerging markets bonds, stocks, and other securities, and according to Barron's, is just part of the erratic nature of these ETFs. But as emerging market ETFs become a more popular investment, it’s not always clear investors understand the volatility underlying them.

The popular ETF iShares MSCI Emerging Market ETF (EEM) had $2.9 billion of outflows, and dropped below $37 a share. The ETF still trades heavily, at a million shares a day. The ETF (with primary holdings in Samsung (SSNLF) and Taiwan Semiconductor ManufacturING ($TSM)) has rebounded in July to hit $39.35. Another emerging market ETF, iShares JPMorgan USD Emerging Markets Bond Fund ($EMB) is up 1.19 percent to hit $109.29, though it’s down 10.99 percent on the year. And the WisdomTree Emerging Markets Equity Income ETF ($DEM), long considered a "safe" emerging market ETF, while currently up 0.75 percent to 49.62 a share, has seen wild swings the last month, and lost nearly 20 percent of its value in June.

This is positively moribund activity compared to 2008. EEM, another "stable" emerging market ETF, was known to have swung up and down wildly that year, at one point losing half its value before gaining it back, as the international markets reacted to economic strife in the US.

The underlying securities of emerging ETFs are, like the economies they invest in, known for their volatility. But the question is whether emerging market ETFs have “caught up” with their underlying security, and thus are due for a correction.

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Dennis Hudachek, an ETF specialist at IndexUniverse, put it this way: “[The difference between the underlying securities and the ETF price] is really about the liquidity of the underlying assets and it just so happens with emerging markets that you do have markets that are relatively less liquid compared to U.S. markets or stocks that trade on the London exchange.”

Some emerging market ETFs have been bolstered by positive economic developments, like China exceeding growth expectations. But this doesn’t mean that emerging market ETFs across the board will stabilize (and, as some analysts like Patricia Oey of Morningstar note, China is already a risky investment). Other ETFs built on less stable economies, like the iShares MSCI Turkey Inv Market Index Fund (TUR) , which invests heavily in the now-turbulent country of Turkey, have plunged.

To some analysts, investors need to better understand these ETFs’ inherent instability, in comparison to ETFs built on more stable investments, or risk getting burned when these ETFs fluctuate. By their nature, emerging market ETFs are built on less stable ground. And the "meat" of them is often poorly understood by investors attracted to the potential. Todd Rosenbluth, Director of ETF Research at S&P Capital IQ in New York, singled out investor ignorance specifically relating to emerging market ETFs, saying, “[investors] need to understand not only what the stocks inside the ETF are doing but the related costs, including volatility and the difference between price and net asset values.”  

Another point to consider when investing in emerging market ETFs, aside from the volatility of emerging economies, is time differential. The American market is open when most emerging markets are closed, and thus react to news in off-market hours. This further exacerbates the swings of these ETFs.

Emerging market ETFs are attractive for the same reason a domestic small-cap start-up is, in that investors feel like they can get in on the ground floor of a growing business with the potential to reap explosive profits. But investors also need to be awar that they’re investing in an unproven sector of the global market, and the extra layer of an ETF isn’t immune to the volatile swings of an emerging market.

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