Flows to emerging markets funds drop by 90%

The flow of money from AJ Bell’s DIY Investors to emerging market funds has decreased by 90% in the last month to 22 September compared to the previous six months.

While the amount of money going into these funds has experienced a sharp drop-off, the number of net buys has decreased less significantly, from an average 1,197 buys per month to 911 last month. This suggests that those removing their money may be investors with large amounts in the stock market and moving away from emerging markets in large sums.

What funds are being bought and sold?

The most-sold emerging markets fund of the past month, Artemis SmartGarp Emerging Markets, was also the most-bought over the past six months. This could be due to shorter-term investors who bought into the fund as emerging markets rose and then decided to sell as the theme lost momentum. The SmartGarp fund uses a formula to find what it sees as the best financial opportunity and is actively managed, so it may be a popular choice among investors trying to benefit off a rising theme. It has outperformed its sector in the past year.

Some other funds have been able to maintain positive inflows over the past month and six months. These include Fidelity Emerging Markets and Invesco Emerging Markets ex-China, showing that not all investors are finished with the emerging markets theme. These funds both follow an index, meaning high weightings to the companies mentioned above such as Taiwan Semiconductor Manufacturing Company Ltd (TSMC), Samsung and SK Hynix. Because the Invesco fund excludes China, it’s worth noting that it will have an even higher allocation to these companies. While this has resulted in a higher return, it also means greater stock concentration risk.

While many of these funds track an index, in emerging markets, which particular index a fund tracks makes a big difference. The Vanguard Global Emerging Markets fund, for example, tracks the FTSE emerging index. It does not classify South Korea as an emerging market and therefore doesn’t include it in this index. However, many of the other funds will track the MSCI Emerging Markets index, which does include South Korea. While this often means a small difference in returns, this year it has been significant because South Korea is home to Samsung and SK Hynix which have both had rocketing returns.

Why are some investors selling?

It’s common for parts of the market to have stronger and weaker months of fund flows. But emerging markets stand out particularly because of their role in the AI theme, and because they had such a strong beginning to the year. The Investment Association’s emerging markets sector has returned about 25% year to date, but the end of that period has been much rockier. The global emerging markets sector peaked in mid-June at an over 30% total return for the year but has bounced up and down since.

Emerging markets surged in popularity earlier this year due to their association with AI. Names like TSMC, SK Hynix, and Samsung have seen major increases in market share because they manufacture the chips and memory cards needed for data centres. Each of these players are quite well established, so many investors took the view that they did not face much market competition, making them a strong AI play.

This led to a big jump in value at the beginning of the year. But now, more analysts feel that these companies are being valued fairly, creating less opportunity for a big growth spurt. In addition, the companies come with risks because of their close link to the AI theme: if their primary purchasers, like Nvidia and Apple for TSMC, were to experience a downturn they would be likely to follow.

Like in the US market, this small group of companies with an AI association make up a large part of the entire market value. In the iShares Emerging Markets Index fund, over 15% of assets are in TSMC. Another 7% are in Samsung, and 5% in SK Hynix. This is an even more extreme scenario than in the US market, where top holding Nvidia accounts for 8% of the S&P 500.