Emerging Markets ETFs: A Rally With Legs

The MSCI Emerging Markets Index is up 16.2 percent year-to-date, more than double the returns offered by the MSCI All-Country World Index. The widely followed developing markets benchmark is on pace for its best annual performance since 2012.

Adding to the emerging markets ebullience is the fact of the top 10 single-country exchange-traded funds on a year-to-date basis, nine are emerging markets funds. Those data points do not mean investors consider stakes in developing economies are late to the party. Some market observers believe there is more to come for emerging markets stocks.

We have upgraded our view on emerging market (EM) equities to overweight, as EM growth stabilizes amid a pickup in global growth and a lower-for-longer interest rate environment, said BlackRock in a recent note.

BlackRock is the parent company of iShares, the world's largest ETF issuer and the sponsor of many of this year's high-flying emerging markets ETFs. The iShares MSCI Emerging Markets Indx (ETF) (NYSE:EEM), the second-largest emerging markets ETF by assets, is regaining favor among institutional investors.

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The iShares MSCI All Peru Capped Index Fund (NYSE:EPU) and the iShares MSCI Brazil Index (ETF) (NYSE:EWZ) are up 74.4 percent and 63.9 percent, respectively, year-to-date, making those the two best single-country ETFs.

Predictably, the Federal Reserve's refusal to yet raise interest rates this year is helping emerging markets assets, including bonds.

The lower-for-longer interest rate outlook reduces the risk of a sharply rising U.S. dollar, expands the scope for EM rate cuts (25 so far this year), and makes high-yielding EM assets relatively attractive. Investors have been warming up to emerging markets since February, and their risk appetite appears to be broadening. Even offshore Chinese equitiesa performance laggard this yearhave started to catch up despite weaker July economic data from China, added BlackRock.

With the Fed holding off on rate hikes and trillions of dollars of negative-yielding sovereign debt throughout the developed world, the iShares JPMorgan USD Emer Mkt Bnd Fd ETF (NYSE:EMB) is also proving to be one of this year's most impressive emerging markets ETFs.

EMB is up an equity-like 14.4 percent this year and has added $4.36 billion in new assets, a total exceeded by just nine other ETFs, including EEM and the iShares Core MSCI Emerging Markets ETF (iShares Inc. (NYSE:IEMG)).

Risks to EM equities include a sudden spike in the U.S. dollar, a renewed weakness in commodities and economic risks in China. Within EM equities we prefer countries showing economic improvement or having clear reform catalysts, including India and ASEAN countries, noted BlackRock.

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