Institutional Investor Inflows Crowd Emerging Market Equities

(April 5, 2011) — As many as 50% of emerging markets equity managers have closed their strategies to new investors, largely due to years of robust performance and investment by institutional investors.

Consequently, finding a skilled, experienced emerging markets managers is getting increasingly difficult as closures have “narrowed the field considerably,” according to research by Pensions & Investments.

Questions about the potential for an emerging market bubble has created skepticism and hesitation among investors, many of whom have considered the sector overbought. However, in the last week or so, according to Reuters, the index has gained considerably. According to data from Cambridge, Massachusetts-based research firm EPFR Global, the emerging market equity funds it tracks ended the first quarter with their highest weekly inflow, a net $2.6 billion, since the first week of January.

Closures have apparently not deterred investors from harnessing the asset class. While investors began shying away from emerging market equities late last year, that trend is reversing, partly spurred by higher interest rates in developed economies. In 2009 and 2010, emerging market equities were at their peak of popularity, with MSCI’s benchmark index for the sector rising almost 150% from March 2009 until mid-January this year.

US financial services firm State Street foresees heightened interest in emerging markets, and urges investors to seize opportunity in smaller markers. According to research carried out by SSgA’s Active Emerging Markets investment team since January 1997, BRIC countries (Brazil, Russia, India and China) have underperformed a group of smaller countries within the emerging world. As of March 2011, according to the firm, non-BRIC emerging market countries outperformed BRICs by 39%.

“Investors, while maintaining a core exposure to BRIC countries, should not close their eyes to other growth areas in the emerging world,” Chris Laine, portfolio manager for active emerging market equities at SSgA, said in the report. “Many of the smaller emerging and frontier economies have quietly been making investor-friendly reforms and deserve the attention of international investors,” he said, referring to the smaller markets of Columbia, Turkey, Chile, the Czech Republic, Egypt, Hungary, Israel, Peru, Poland, Thailand and the Philippines.

An earlier study by Aberdeen, the global investment management group overseeing more than $287 billion of assets for institutions and private individuals, has found that schemes remain cautious over emerging market debt, with limited knowledge about emerging market debt perceived as the most popular roadblock to investing. Nevertheless, the firm acknowledged the significant value of investing in the asset class. “Emerging Market Debt (EMD) has generally remained one of the best performing asset classes for over 10 years, despite high-profile crises,” the firm stated. “In our view EMD has the potential to enhance returns, providing diversification benefits for investors. We believe that most investors should at least allocate a modest holding to emerging debt, while investors more tolerant of risk should consider a more significant holding.”