Emerging markets have become a victim of China's success in 2020, with money managers and investors now underweight and pulling assets from equity and debt allocations as they watch and wait for better times to resume.
The recovery in the U.S. dollar, an increase in safe-haven asset yields in the first quarter and China's tighter monetary policy have contributed to the underperformance of emerging market assets vs. developed market assets so far in 2021.
On top of that, developed markets continue to ride the vaccine- and stimulus-induced wave of positive performance, marking these regions' recoveries and setting them further apart from emerging markets.
Emerging markets equity funds tracked by data provider EPFR ended the second quarter of 2021 with a three-week run of outflows. For the second quarter, net inflows dropped to $15.9 billion, following $68.4 billion in net inflows for the first quarter of 2021 and $44 billion in net inflows for the fourth quarter of 2020, according to EPFR.
As of June 25, emerging markets bond funds saw an 11-week run of inflows come to an end as they posted their biggest weekly outflow since early March, according to EPFR. Figures were not available. At the end of the second quarter, investors had pumped $13 billion in net inflows to emerging markets bonds funds. That followed $11 billion in net inflows in the first quarter of 2021 and $45 billion in net inflows in the fourth quarter of last year.
While investors sought more exposure to risky assets, including emerging markets, in the second half of last year and the first quarter of this year, they have gradually dialed down their appetites in the second quarter of this year. Both investors and fund managers moved to reduce their exposure to emerging markets due to fears that tighter Chinese monetary policy will hit the country's growth and its demand for other emerging markets' commodities exports, EPFR said.
In the first half of 2021, the MSCI Emerging Markets index delivered a performance of 7.5%, below the 13% recorded by the MSCI World index over the same period. The Emerging Market Bond Index Global Diversified returned -0.72% year to date as of July 6, while the local currency Government Bond Index-Emerging Markets Global Diversified returned -4.19% for the same period.
Investors said they are now waiting for more signals that emerging markets will do better before they will move to an overweight position.
Luc Vanbriel, Brussels-based CIO of the €2.5 billion ($3 billion) Pensioenfonds KBC, said in a telephone interview that the fund is slightly and temporarily underweight its tactical allocation to emerging market equities, which accounts for 10% of its overall equity allocation. The fund's total equity allocation was not available. Similarly, the fund has been reducing its tactical exposure to emerging market bonds to a fifth of its total bond allocation of 18.5%. "We are positive on listed equities, underweight emerging markets because we are overweight eurozone equities," he said. "We keep on assessing the situation. Emerging markets still have to recover more than North America and Europe. It might be that in six to 12 months we are overweighting emerging markets," he said. "China has outperformed in 2020. The rest of emerging markets were slightly underperforming but they will catch up. They have high growth rates and that's the reason why we want to be in emerging markets," he said.
State Super, Sydney, is currently underweight emerging market equity in its A$8 billion ($6.1 billion) defined contribution portfolio and neutral in its A$34 billion defined benefit portfolio. CIO Charles Wu said the allocation in the DC portfolio is at about 7% — under the fund's strategic allocation of 9%.
"We are not increasing emerging equity exposure. At this stage, we have preferred to take risk in developed markets. We are now dealing with infrastructure-type questions — for example, if there is enough capacity to respond to COVID-19 outbreaks," he said in a telephone interview, referring to concerns over emerging markets' preparedness for coronavirus variants. "There are other places where the capital can be channeled," he said.