Risk appears to be back in vogue. While most investors are wary of the European and U.S. stock markets, money has already been pouring into emerging markets so far this year, with funds dedicated to the asset class enjoying their best start to a year since 2006.
Globally, emerging market equity funds attracted $3.5 billion in the week ending February 1, despite falling out of favour for much of last year. The year to date inflows total $11.3 billion, according to a report on FT.com.
Not settling for the stock market, investors have also parked $1.2 billion in emerging market bond funds, the most since March last year. Due to capital inflows, emerging market currencies have also enjoyed a strong start to the year.
“The appetite towards emerging markets has been so far remarkable,” strategists at Société Générale said in a recent note. “To a large extent, it has reflected some [European] debt crisis fatigue, and the fact that investors have been keen to put risk back on to the table.”
Jerome Booth, head of research at Ashmore Investment Management, has also commented on the fast climb of emerging markets in 2012. He believes there’s a strong case that “…we do not face a plethora of potential large permanent losses from multi-country investing in emerging markets in 2012.” This risk is much higher in the developed world, he says.
“Emerging countries no longer share the common feature of potential default should they be cut off from foreign capital for the simple reason that they are now often the net creditors,” writes Booth. “All their main risk scenarios are either country specific, or emanate from the mess in the developed world. The latter scenarios all pose greater risks for those invested in the developed [world].”
In Booth’s view, one of the most likely outcomes of renewed investor confidence, alongside dollar weakness, will be “a more gradual diversification and reduction of emerging market central bank reserves.”
Booth also asserts that the secret to unwinding global imbalances over the medium term lies in emerging market currencies. As they appreciate, trade flows should rebalance, and their rise will be only temporarily interrupted by short periods of risk aversion.
Overall, the FTSE All-World Emerging index has gained more than 15% so far this year, and has led many analysts to question whether its momentum can be maintained amid continued investor wariness over developed markets.
As result of investor fear, and despite claims put forward by professionals like Booth, skeptics maintain that emerging markets remain at risk from a resurgence of Europe’s sovereign debt crisis, and any faltering of economic growth in the US and China.
“While we entered into 2012 with a constructive tone, the magnitude, intensity and the breadth of the EM asset rally naturally raises the question whether the market has rallied too far, too fast,” Barclays Capital analysts said in a research note.