BlackRock’s ETF is an outsized loser in emerging-market sell-off

EXCHANGE-traded funds (ETF) that buy emerging-market equities are undergoing a churn – and the biggest loser is the BlackRock fund that helped usher in passive investing to the asset class two decades ago.

Investors have withdrawn US$4.6 billion from the iShares MSCI Emerging Markets ETF since July – of which US$1 billion, or 6 per cent of its assets, fled in the past five days alone. Combined with an equity sell-off during this period, the fund’s assets have shrunk to the least since March 2020. It’s now US$17.7 billion fund compared with US$53 billion a decade ago.

ETF watchers say investors are turning away from broad-brush emerging-market funds that track benchmark indexes as they seek targeted exposure to specific countries, sectors and investment styles. The BlackRock fund, widely known as EEM, has become a victim of this trend, as it has been a virtual flagship of the asset class since 2003 and the first to be dumped when risk sentiment deteriorates.

“Traders look at EEM as an easy button for broad emerging-market exposure,” said Ben Johnson, head of client solutions at Morningstar. “EEM is just that big red button on your trading desk that says I want to put this bet on or I want to take it off.”

Fund managers and analysts say EEM’s outflows have been deepening since 2018 because of its focus on large, benchmark-listed stocks at a time when some of the best investment opportunities came from smaller, newer companies in an expanding emerging-market universe. With long-term investors switching to funds that also offer small-cap opportunities – such as BlackRock’s own iShares Core MSCI EM ETF – EEM has been reduced to a domain of traders and hot money.

The fund’s capital losses contrast with its main rivals, which have hardly seen outflows during this year’s sell-off. BlackRock’s core EM fund, also known as IEMG, is sitting on about US$3.7 billion of net inflows year-to-date. The US$70 billion Vanguard FTSE EM ETF, or VWO, has had just one day of outflows in 2023 and has already seen inflows resume.

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While a third quarterly slump in emerging-market equities has sparked ETF outflows across the board, some select country-specific ETFs where investors see potential for economic growth are already seeing a resumption of inflows. India and Brazil are two examples.

China factor

A US$1 trillion sell-off in Chinese stocks, led by technology companies, has also weighed on ETFs with a large exposure to the country. As much as 27 per cent of EEM’s funds are in Chinese stocks – a reason for investors bearish on the world’s second-biggest economy to withdraw funds. BlackRock’s fund that invests in emerging markets outside China has received inflows of US$677 million in the past two months.

“iShares has more than 1,300 ETFs to serve the broadest set of clients – asset owners, asset managers, wealth, individual investors,” BlackRock said in an e-mail response to questions. “EEM is one of the world’s most liquid emerging markets ETFs which enables investors to efficiently access and express their views on this market segment.”

Smaller equities are outperforming large-capitalisation stocks this year, extending a trend that started in March 2020. Since then, small caps have handed emerging-market investors a return of 111 per cent, compared with 24 per cent in their bigger peers.

While emerging-market stocks have been sold off since the end of July amid rising US yields and China’s economic woes, the EEM ETF has its own idiosyncratic factors that have worsened the pain – such as the cost of holding it.

The fund’s expense ratio is 0.69 per cent, several times those of IEMG and VWO. As developing nations underperform US markets, investors may be becoming more cost-sensitive.

Emerging-market stocks have erased US$1.66 trillion in market value since July and are heading towards a third successive annual loss. US-listed emerging-market ETFs witnessed US$612.4 million of outflows in the week ended Sep 29. BLOOMBERG