Believe It or Not, EM Equities Are Still A Massive Underweight

Following the flows of funds may provide interesting clues as to where investment opportunities still lies. EM are probably one of them.

Source: JPMorgan

Per JPMorgan’s Flow & Liquidity report, dated Feb 10, 2017:

« In contrast to China, capital flows into the rest of EM improved markedly in January.

This follows an overall positive 2016 for EM ex China which saw a total capital inflow of $120bn vs. an outflow of $600bn from China.

EM economies ex China are thus seeing decent capital inflows again, having suffered only short-lived disturbance from last November’s US election.

EM equity and bond ETF flows show a similar picture with a strong rebound in EM ETF flows YTD.

Despite the significant inflows into EM ETFs over the past year, our positioning metrics, based on the EM share in equity or bond ETFs divided by the EM share in global equity or bond indices respectively, have failed to improve.

This is because even more money was invested in non-EM ETFs over the same period, especially after the US election, pushing the EM share in our metrics to lower levels.

These ETF-based positioning metrics are currently pointing to very underweight EM equity positions and neutral EM bond positions.

Big underweight positions in EM equities act as a backstop limiting their downside in the presence of negative news and helping them to outperform in the absence of news.

Indeed, the EM equity outperformance during the month of January, in the absence of any significant EM news, is consistent with this view. »

Source: JPMorgan

« The EM equity share was little changed in January this year. It fell sharply in Q4 last year after a stability phase during Q2/Q3 2016. In other words, despite the $24bn or 11% of AUM invested in EM equity ETFs since the beginning of 2016, this metric declined, pointing to an even more extreme EM underweight currently. This is because even more money was invested in other equity ETFs outside EM over the same period, especially after the US election, pushing our EM metric to even lower levels in Figure 5. One needs to go back to 2005 to see such an EM equity underweight. »

Same trend is observed for EM bonds.

In conclusion, despite an attractive valuation and better fundamentals, investors are still far from being overweight EM assets in their allocation. This might sound strange, but you have to admit EM come a long way.

The main reason is that, excluding India, the BRC trio has been more or less in financial and economy jeopardy: Russia and Brazil have been in recession with their currency plunging over the last years, while China for a long period of time did not show any ability to control its growth without manipulating credit supply.