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Are EM ETFs the New Definition of Developed Market Investing?

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Emerging markets’ (EM) equities had a dream run last year. The rally was prompted by accommodative developed market central banks that kept interest rates low and drove investors toward the relatively high-yielding EM bloc (see all Broad Emerging Market ETFs here).

An overall boom in the global economy, a subdued greenback and commodity market strength were also the wind under the wings. The trend is also equally bullish this year and seems to be steady in the coming days despite the ongoing trade-related volatility. Let’s delve a little deeper.

EMs in 2018: Look Like Developed Market?

Falling Inflation in Some EMs

Goldman Sachs believes that many emerging market economies have started showing developed market characteristics as inflation rates are declining and the currency crises is easing. Brazil, which once struggled a lot to manage sky-high inflation, saw inflation drop in March 2018 to the lowest annualized rate for the month and quarter since the mid-1990s (read: Q1 ETF Asset Report: Developed Markets Win, High-Yield Loses).

Another economy, India, too was known for high inflation. In 2013, the economy had inflation of 9.4% while it dropped to 3.8% in 2017. In February, consumer prices in India grew year over year to 4.28%, below 5.07%in January and market expectations of 4.8%.

Low inflation rates are helping many EM central banks to adopt easy money policies, which in turn is facilitating growth. This factor clearly resembles developed market central banks.

Declining Correlation with U.S. Rate Policies

The fading relationship between emerging-market policy and U.S. rates suggest that the bloc is less susceptible to the fast Fed policy tightening, per Goldman. In any case, Deutsche Bankonce noted that the correlation between EM performance and the benchmark U.S. Treasury yields since 2010 has been positive except for 2013.

Hideo Shimomura, chief fund manager of Mitsubishi UFJ Kokusai Asset Management, noted that gradual decoupling of the two zones’ credit cycles should lead investors to emerging economies with solid growth prospects such as in Southeast Asia and Eastern Europe. The bloc appears much more self-sufficient now.

Are EMs Washing Away ‘Original Sin’?

Goldman also indicated that “the extent to which emerging markets suffer from “original sin” -- the inability to issue debt denominated in their own currencies -- has declined considerably since the 1990s. The decline in currency mismatch has reduced the risk of a currency crisis, and provided central banks greater space to pursue objectives such as price stability,” as quoted on Bloomberg.

Local currency-denominated bonds make up a substantial share of developing economies’ debt at this moment. This cuts out countries’ “dependence on flighty foreign capital.” iShares JP Morgan EM Local Currency Bond ETF (LEMB - Free Report) is up 4.5% this year.

Are There Any Downside Risks?

Policy tightening in the United States only may not pose threats to EM investing, but all major forces — the United States, Euro region, Japan and U.K. — added together may derail EM growth momentum once they start policy tightening, per Nomura.

The ongoing talks of a trade war between the United States and China is another threat, though not huge. Plus, elections in a number of developing nations may cause some volatility. 

ETFs in Focus

Below we highlight a few broader emerging market ETFs that have been steady this year and beat SPDR S&P 500 ETF (SPY - Free Report) (down 1% YTD).

SPDR S&P Emerging Markets Dividend ETF (EDIV - Free Report) – Up 8.3% (read: 6 Dividend ETFs of 2017 With At Least 3% Yield & 17% Gains)

iShares MSCI Frontier 100 ETF (FM - Free Report) – Up 6.0%

Schwab Fundamental Emerging Mkts Large Company ETF (FNDE - Free Report) – Up 5.1%

PowerShares DWA Emerging Markets Momentum ETF (PIE - Free Report) – Up 4.6%

iShares Emerging Markets Dividend ETF (DVYE - Free Report) – Up 4.1%

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