Will tapering topple the ETF boom?

As the end of quantitative easing nears, emerging market ETFs have been hit badly. While some have signalled the market is set to crash at breakneck speed, others think forecasts of doom are overblown.

What does quantitative easing (QE) in the US have to do with emerging market exchange traded funds (ETFs)?

With debt so freely available and government bond yields at all time lows, a large amount of capital has flowed into emerging markets in recent years. The reasons are twofold. Firstly, while western markets have been depressed, particularly in Europe, emerging markets have fared better and offered larger returns, making them a good place to put money to work.

However, traditionally emerging markets have been off-putting despite their potential for returns. Lax regulation and questionable accounting standards mean that for many investors the emerging markets were simply too risky. But with governments buying bonds there was much less risk to investing in these markets. Thus, many put money to work and often through an emerging market ETF, which would help them to gain exposure to a broad basket of emerging market securities without having to worry about particular investment rules in a given country. 

What exactly has happened since Ben Bernanke signaled the end of QE?

Shortly after Bernanke first hinted that the Federal Reserve would begin to taper its QE program, emerging market ETFs saw significant redemptions. Around US$6.6 billion was pulled from emerging market ETFs in June. Gold and bond ETFs were also badly affected with multi billion dollar redemptions.

Some ETFs saw so many cash calls that they were forced to suspend further redemptions. Some market experts even went as far as to state that the outflows were far in excess of what models had predicted in worst-case scenarios.

What does this now mean for emerging market ETFs?

There has been criticism that some market commentators slightly over-egged the case for the ETF market collapsing. Just last week, Bernanke's testimony in front of Congress, in which he said the Fed wasn't following a "preset course" and would depend on economic circumstances, helped give emerging market ETFs a lift. The iShares MSCI Emerging Markets Financials ETF climbed 6.4% on 16 July, while its Latin American ETF gained 2.58%.

Furthermore, ETFs generally have been growing very strongly in recent years. Up to the end of June, equity ETFs had seen net inflows of around US$105.3 billion, almost double the US$53 billion seen in the same period of 2012. While some types of ETF have fallen back a little since the Fed announced its QE plans, this fall is relatively minor compared to the overall size and growth rate of the market.