Emerging Market Funds Get Their Shine Back

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Emerging markets have had a rough ride in recent times.

But the benchmark FTSE Emerging Markets Index has roared back in 2014, returning 7.99%. It lost 3.79% in 2013 while indexes tracking developed markets in the U.S. and abroad rose to new highs.

In a sharp reversal, it's now beating them.

"Investors are really moving back into it," said Todd Rosenbluth, director of ETF and mutual fund research at S&P Capital IQ, during a webinar last week.

Emerging market ETFs saw $9.8 billion inflow in Q2, swinging from an $11.7 billion outflow in Q1. ETFs tracking developed international markets saw inflow drop to $12.96 billion from $14.68 billion.

And in July, iSharesMSCI Emerging Markets ( EEM ) was the second most popular fund in terms of new money after SPDR S&P 500 ( SPY ), raking in $1.9 billion, according to FTSE Emerging Markets ( VWO ) added $1.24 billion.

Shares of EEM have climbed 5.41% in 2014 and VWO has gained 7.74%. Meanwhile, iSharesMSCI EAFE ( EFA ), tracking developed international markets, has lost 0.31%, and SPY, tracking the broad U.S. market, has gained 5.6%.

There may be good reason for this surge, analysts say. Valuations of emerging market stocks remain lower than those of U.S. and other developed markets. Besides being cheaper to buy, they help diversify portfolios. And the stronger growth prospects of emerging economies could boost returns.

But volatility is an issue. Almost all the gains in emerging markets this year came in Q2, largely driven by bullishness on China.

"Emerging markets had a terrible start to the year," said Dave Nadig, chief investment officer at "Now that the returns are beating the other major stock markets , money is flowing back in."

Experts caution against a monolithic view of the segment.

According to Morningstar Inc., the Russian exchange lost 14.5% in the first quarter as the Crimean crisis unfurled, while the Indian exchange gained 8.2% on favorable political news.

"As an emerging market investor, you have to have an opinion on individual countries," Nadig said. "Otherwise, you're just throwing darts."

Even two broadly invested emerging market ETFs may differ greatly. For example, someone seeking to invest in South Korea would get 15.27% exposure through iSharesCore MSCI Emerging Markets ( IEMG ), but none throughVanguard FTSE Emerging Markets ( VWO ).

The latter's underlying index considers South Korea to be a developed country. In the past 10 years, iSharesMSCI South Korea Capped (EWY) returned an average annual 12.45% vs. 11.81% for EEM and 6.84% for EFA.

As interest in emerging markets grows, so does the slicing and dicing of the segment. Beyond BRIC ETFs offer exposure to emerging markets other than Brazil, Russia, India and China. Frontier market ETFs include countries such as Oman that are even less developed than most emerging nations.

EGShares Beyond BRICs (BBRC) crossed $250 million in assets this month. It started the year with $22 million. Marten Hoekstra, chief executive of Emerging Global Advisors, attributes much of the outperformance to its 25% frontier market exposure. BBRC is up 9.67% in 2014, besting developed and emerging market indexes.

Smaller countries and companies in emerging markets hold especially promising opportunities, Dave Mazza, head of research for SPDR ETFs, agrees.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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