In fund investing, popular children are to be shunned. As a general rule, fund categories that enjoy high net cash inflows tend to perform relatively poorly over the next several years, while those that suffer net redemptions usually fare well. This upside-down behaviour is apparent across the globe and among various asset classes. Investor sentiment is a useful indicator of a security's future prospects.
Recent sentiment has not favoured emerging-markets stock funds. As Russ Kinnel, Morningstar's director of mutual fund research, points out, emerging-markets funds have been bucking the usual pattern that weak performance leads to cash outflows. The category roared back from its 2008 losses with a big gain in 2009, but since then it has been treading water and has trailed pretty much all stock and bond categories. Meanwhile, cash keeps flooding in.
Russ has not been surprised, therefore, to see emerging-markets stock funds lag again this year. As he states, yes, stock prices have been getting lower, and cheaper is better than expensive, but as long as fund investors remain fond of the category, it's hard to be too enthusiastic about its prospects.
Dawn may be approaching, however. The Wall Street Journal reported a few days back (subscription required) that the world’s emerging-markets funds face an investor "exodus." Exodus is a lovely word for the sentiment investor! Unfortunately, the news wasn't quite that good.
With sentiment improving (in the perverse sense) and valuations at the point where GMO estimates that emerging-markets stocks have the highest expected seven-year returns among the asset classes, emerging-markets funds may be a timely investment.*
*Disclaimer: I don't make investment recommendations, I'm not a financial adviser, I might not have a clue and Compliance would never want me writing such a thing. You know what I mean, though: the category interests me.
Read John Rekenthaler's previous articles here.
