ETF investors yanked more money from funds invested in the Euro zone than they did from the United Kingdom in the third quarter of this year. Overall, Euro-area assets saw net outflows of about $5 billion, or 4.9% of their net assets at the start of Q3. Some individual countries in the Euro saw much larger outflows: Belgium, Spain and Germany had outflows of 10.2%, 8.6% and 7.8% of net assets, respectively. Meanwhile investors withdrew only about 1.3% of funds invested in the U.K.
This may be a bit surprising post-Brexit. Funds such as the iShares MSCI United Kingdom ETF (EWU) lagged their Euro-area counterparts such as those in the iShares MSCI Germany ETF (EWG) badly in Q3, though much of this was due to the currency losses suffered by the British Pound, which made the shares of companies held by EWU worth less in U.S. Dollars. Still, it appears that by not yanking much money from funds like EWU, investors are taking a wait-and-see attitude with regard to Brexit.
The other notable trend from our analysis of ETF fund flows from Q3 is investors’ continued enthusiasm for emerging market funds, both in the equity and fixed income space. Among equities, although investors put about 73% of new money to work in developed markets, emerging markets took in the remaining 27%. That’s far greater than emerging markets’ roughly 10% share of global market cap, meaning that investors have been “over-allocating” to emerging markets in recent months (Figure 1).
Figure 1: Fund Flows versus Market Cap in Q3 2016
Source: ETF Research Center and DTCC
The story was similar among fixed income ETFs. While much bigger domestic Corporate Bond and Aggregate Bond funds gathered the lion’s share of assets, it was Emerging Market Bond funds that were punching above their weight. Overall, investors put new money equal to more than 16% of assets to work in Emerging Market Bond funds, compared to about 10% for Corporate funds and less than 5% for Aggregate funds.
We recently initiated coverage on the iShares J.P. Morgan Emerging Market Bond ETF (EMB), which contains only USD-denominated issues. Despite the category’s recently popularity we found that EMB still appears to offer solid risk-adjusted yields.
What do you think? Are investors right to take a wait-and-see approach to U.K. stocks after the Brexit vote? Are investors too enthusiastic about emerging markets?
 We measure “net flows” instead of total money flows as a better gauge of investor sentiment. Net flows strips out the portion of ETF assets that are held as short interest. Authorized participants often create new ETF shares to meet demand for short sales. We believe it is misleading to characterize this inflow of funds as bullish; likewise it is misleading to view outflows that are simply the unwinding of short positions as bearish.