Even with the S&P 500, which has been among the better performing indices over the past year, returning 24% moves closer to its 2007 highs, the current divergence between EM and DM equity fund flows has hit its highest level ever. ?The share of EM in equity fund AUM (assets under management ) globally, has declined to its lowest level since the beginning of 2010 and stands significantly below its historical trend,? JP Morgan said in a recent report.
Although the last one year?s returns show that emerging markets (EMs) as a whole have fared well, of late money has been moving out of EMs and into developed markets(DM). The week ended February 18, saw a further $5.4 billion outflow from EM equity funds, the fourth week in a row bringing the 4-week average to -$5 billion, the largest since JP Morgan has data, starting 2001. In sharp contrast, DM equity funds saw a very large $12 billion inflow.
The primary reasons for the rotation of money which was pouring into EMs last year ? India received record flows of $29 billion ? are the rising inflation and interest rates in developing markets which are threatening to hurt growth. In contrast, the recovery in the US, which is expected to grow at 4% this year, is attracting equity flows as investors correct their large underweight positions. The February Merrill Lynch Fund Manager survey showed the highest ever percentage of global asset allocators reporting an overweight overall position in equities. At the same time, the percentage of investors reporting an underweight in EM equities fell to the lowest since March 2009.
Indeed, markets like India have been worst hit this year with money moving out and bringing down the MSCI India by about 16% in the last three months even as the S&P gained 10%. While markets like Korea and Taiwan too have done extremely well posting returns of over 30%, in the BRIC universe, only Russia has been a big outperformer, while markets like India, China and Brazil have given returns that are in low double digits.
Much of the underperformance of the Indian market has taken place in the last few months, especially since the start of 2011. Even after the correction, though, India remains expensive relative to other markets in the region such as Korea, Thailand, Indonesia and China which are trading at lower multiples. For instance, the Sensex now trades at a price to earnings (P/E) multiple of around 14 times one year forward earnings while the Korean and Chinese markets trade just above 11 times and the Indonesian market trades at just under 13 times. Looking ahead, economies like India need to demonstrate that inflation is under control and growth is on track ebfore they can hope to trade at higher multiples. In the meanwhile political problems in the middle east could prompt investors to seek out safer markets.