The story behind emerging market outflows

After a strong two-year run, some investors are starting to turn on emerging markets. The combination of tightening monetary policy in the U.S. and Europe, higher oil prices and the threat of a global trade war has led to outflows from emerging markets.

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More than $1.4 billion flowed out of the iShares MSCI Emerging Markets ETF on Monday, Bloomberg reported. That followed $2.2 billion removed from the fund last week—the most in a single week since January 2014.

Chris Ibach, global portfolio manager for Principal Global Equities in Des Moines, Iowa, isn’t giving up on emerging markets, though. In a May 23 interview, he said there’s still a “solid foundation to work from” and he expects emerging markets will continue to grow.

“There are always issues in emerging markets that you have to wrangle with,” said Ibach, whose firm is one of three managers of the Renaissance Global Equity Private Pool.

Those issues include political turmoil in Brazil causing “significant volatility,” he said, as well as ongoing sanctions against Russia. Argentina’s interest rate has skyrocketed to 40% as the peso plummets, leading to a $50-billion IMF loan, while political risk in Turkey has devalued the lira.

Read: Advisors concerned about rising rates, volatility

Many developing countries are also being disproportionately hit by rising commodity prices. The Wall Street Journal reported last week that while a handful of oil exporters—Saudia Arabia, Russia and the United Arab Emirates among them—would benefit from higher oil prices, manufacturing countries such as Pakistan, Thailand, Vietnam and the Philippines would take a hit.

The impact on China and India would be “moderate,” the report said, while Argentina and Turkey, whose currencies have dropped against the dollar, would find oil especially expensive.

Monetary policy in developed countries

Last week, the U.S. Federal Reserve raised its benchmark interest rate for the second time this year and indicated it would likely do so twice more before the end of 2018. The European Central Bank set a schedule to phase out its bond purchasing program by the end of the year.

Read: ECB to begin phase out of stimulus program Read: Fed raises key rate, signals 4 rate hikes this year

Rising U.S. rates have contributed to a stronger currency and higher Treasury yields, which have attracted capital from some emerging markets.

Central banks becoming less accommodating presents “a little bit of a headwind” for emerging markets, Ibach said, but he doesn’t see it as too “aggressive or disruptive.”

After all, the changing monetary policy reflects a strong global economy, from which emerging markets will continue to benefit, he said.

A National Bank report from earlier this month said that—Argentina and Turkey notwithstanding—many emerging market economies are better placed now than during the 1997 Asian financial crisis due to increased foreign exchange reserves and smaller external deficits.

“I wouldn’t expect returns in emerging markets like we’ve seen in the last two years, but I do think it will still be structurally positive,” Ibach said.

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