The rise of emerging markets ETFs
October 18, 2012 2:00 am by Pan Kwan Yuk
The popularity of exchange traded funds seems to know no bounds. ETFs, or open-ended investment funds that trade on stock exchanges like stocks, have emerged from nowhere in recent years to control over $1.7tn in assets under management.
While most ETFs track the return of an equity index such as the FTSE 100 or the S&P 500, their ease of use and low fees have also make them the big new story in emerging markets investment.
Consider this: of the $60.2bn that have gone into emerging markets funds for the year to October 10, 35 per cent (or $21.36bn) have gone into ETFs, according to EPFR.
The funds’ presence is most pronounced in equities where 82.6 per cent of inflows into EM equity funds so far this year have been done via ETFs. (By contrast, they account for 13 per cent of the total inflows into EM bond funds).
“We have seen a significant amount of inflows into emerging markets being done via ETFs in the past couple of years,” Jim Ross, global head of State Street’s ETF business, told beyondbrics. “The trend among investors is to diversify their holdings away from the US and western Europe. But how to do it is a trickier question.”
“In the US, we can all go out and buy stocks on the stock market.” said Ross. “But it’s much harder for US investors to go out and buy stocks in emerging countries like China or Brazil or Sri Lanka.”
Indeed, before ETFs came along, ordinary individuals could get exposure to emerging market by going to a mutual fund manager, who charged a hefty fee. But in the current low-growth and low-yield environment, investors are increasingly taking a hard look at the costs and benefits of using active managers compared to passive investment instrument like ETFs.
“ETFs are very good instruments for emerging markets because even for asset managers, buying the actual securities of countries like Malaysia or China can be a very time consuming and complicated affair,” said Daniel Gamba, head of the America iShares institutional business at BlackRock. “You have to set up a custodian account, work with local broker-dealers and really do your homework on the stocks.”
“ETFs give people a cheaper option to accessing emerging markets, particularly the smaller and more illiquid markets,” Gamba continued. “They could buy just one stock, listed on a major exchange, that would track the entire market and be relatively easy to buy and sell.”
Given the advantages, it is no wonder that they have surged in popularity. There are now over 700 EM-dedicated ETF – more than twice the number just 3 years ago, according to ETFGI, a consultancy. Together, they attracted in the first nine months of this year 9.4 per cent of total ETF inflows ($130.7bn).
In other words, almost 1 in every 10 dollars flowing into ETFs in 2012 has gone into emerging markets funds. Four of the ten most heavily-traded ETFs by volume are emerging markets, according to ETFdb, a data provider. Broad index trackers such as the $57.4bn Vanguard MSCI Emerging Markets Index and the $37bn iShares MSCI Emerging Markets Index are the most popular (they are the third and fourth largest US ETFs by assets), followed by country specific ETFs like iShares’ MSCI Brazil Index Fund and its FTSE China 25 Index Fund.
But like so many financial innovations before it, ETFs are not without their risks.
One concern is with liquidity. In theory, investors should be able to buy and sell shares of the ETF with relative ease because they are listed on the stock exchange. But the reality is that the success of an ETF is dependent on the the popularity and liquidity of the underlying asset that is being traded.
In simple terms: the more traded the fund, the more likely you will be able to buy and sell your shares without incurring huge trading costs.
This is unlikely to be a problem for those trading in large established EM ETFs like the Vanguard and iShares MSCI Emerging Markets Index, which respectively have average daily trading volumeS of 19.3m and 42.7m shares.
But it could be an issue for those who choose to dabble in more niche ETFs like Guggenheim’s Yuan Bond ETF, which has an average daily trading volume of just 787 shares.
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