Mom and pop can't quit emerging-market stocks. And that's good

Retail investors showing uncharacteristic resiliency in the face of lackluster performance.
OCT 21, 2013
Mom-and-pop investors are best known for their penchant for performance chasing, but they're showing an unusual commitment to emerging markets — even as institutions pull back amid lackluster performance. Typically, big institutions such as pension funds and endowments — often called the smart money — lead the pack but this time, roles are reversed, and financial advisers are happy about it. The MSCI Emerging Markets Index, a popular benchmark of emerging-markets stocks, has fallen more than 10% this year while the S&P 500 has rallied more than 18%, but a look at mutual fund flows, which are primarily driven by retail investors, tells a completely different story. Diversified-emerging-markets funds have had net deposits of $27 billion this year through July, while U.S. large-cap stock funds have had net deposits of just $5 billion, according to Morningstar Inc. “It's really surprising how resilient the flows have been,” said Mike Rawson, a mutual fund analyst at Morningstar. Emerging market funds have not posted net outflows since February 2011. “It's refreshing to see that retail investors haven't abandoned emerging markets,” he said. “Just because performance is bad, it doesn't mean you should sell everything.” The resilience is drawing some rave reviews from advisers. “We're seeing good discipline at work,” said Kate Stalter, investment adviser at Portfolio LLC. “That's a very encouraging development.” Emerging-markets stocks have rapidly become a larger part of since the financial crisis, thanks to the allure of the fast-growing countries. Since 2009, emerging-markets-stock funds have nearly doubled as a percentage of all equity fund assets, according to Morningstar. Today, investors have just under 8% of all equity fund assets in emerging-markets funds, up from 4% in 2009. The growth argument started to break down around the middle of last year, however, said Kristina Hooper, head of investment strategies U.S. at Allianz Global Investors. “Investors have been told emerging markets offer growth, which has been hard to find anywhere, for years now,” she said. “The dynamic really started changing last year. Growth has been disappointing.” The helps explain why large institutional investors that use exchange-traded funds for easy access in and out of asset classes have been scaling back on emerging markets this year. The $48 billion Vanguard FTSE Emerging Markets ETF (VWO) and the $35 billion iShares MSCI Emerging Markets ETF (EEM) had a combined $10.8 billion pulled out by investors this year through July, according to IndexUniverse LLC. That doesn't mean that retail investors should be following suit. “Investors with a long-time horizon are right on in staying the course,” Ms. Hooper said. Ms. Stalter has been re-balancing her client portfolios to move assets from U.S. stocks into emerging markets. “Emerging markets have never been cheaper,” she said. “It's a great time to get into some of the smaller areas of emerging markets.”

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