Energy in Emerging Market ETFs

Investors are kicking off 2012 with a greater appetite for risk, leaving memories of last year’s muted stock market performance in the dust. Renewed optimism is benefiting one industry in particular: U.S. exchange-traded funds (ETFs), which attracted the largest single monthly cash inflow in more than two years in January.

According to data compiled by the ETF Industry Association, inflows reached $28.8 billion during the first month of the year.

Among the top gainers are emerging market ETFs, a drastic turnaround from the sector’s disappointing performance in 2011.  The largest emerging market stock index ETF, Vanguard MSCI Emerging Markets (NYSE:VWO), saw the biggest boost in assets throughout the first four weeks of the year, recording inflows of $3.25 billion. The fund’s strong start to the year is earning it attention; it climbed 10.8% in January and is up another 2.1% as of Wednesday.

Michael Krause, president of AltaVista Research, expects the upward trend in emerging markets to continue in 2012. He says last year’s downfall makes current valuations attractive to investors.

“This is a risk-on, risk-off thing. Right now, its risk-on,” said Krause. “It’s a result of emerging market ETFs falling so hard last year. The prices are low.”

Vanguard MSCI Emerging Markets fell 18.73% in 2011, the fund’s worst performing year since the 2008 financial crisis when it plummeted more than 50%.

Vanguard’s VWO isn’t the only top performing emerging market ETF. The iShares MSCI Emerging Markets (EEM) surged in January, climbing 11% while attracting inflows of $1.28 billion.

Both funds mirror the performance of the MSCI Emerging Markets Index, which more than doubled the iShares S&P 500 Index (IVV) year-to-date return of 5.5% through January. And the MSCI Emerging Market Index is pushing higher in February, up another 2.9% as of yesterday.

But Krause isn’t overly optimistic. He’s cautious of increased volatility and risk in BRIC exchange-traded funds, or funds investing in Brazil, Russia, India and China.

“It’s wise to stick with the conservative plays in emerging markets,” said Krause. “Higher beta in these funds means more risk, and from what I can tell, certain emerging markets like China are overheated.”

So far this year, that’s not the case; BRIC ETFs are among the leading performers in the sector, with multiple funds posting year-to-date returns of more than 15%. The iShares MSCI BRIC Index (NYSE: BKF)  climbed 16.3% during the first four weeks of the year, and another 3% as of Feb.8.