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EM rally a head fake? Risks to watch

A worker carries prints of R$ 50 Brazilian reais bills during the production process at the Casa da Moeda, the national mint, in the Santa Cruz suburb of Rio de Janeiro, Brazil.
Dado Galdieri | Bloomberg | Getty Images

Investors are dipping back into emerging markets, but some analysts warn the appearance of a recovery overlooks a number of potential risks in the battered asset class.

EM equity funds reversed 17 weeks of net redemptions to end the first quarter with their longest run of inflows since the third quarter of 2014, according to EPFR's Global Fund Flows and Allocations Data.

However, the inflows came solely from exchange traded funds, typically seen as short-term investments. Meanwhile, the most recent data shows those ETF inflows are moderating, at 487.1 million this past week versus 910.13 million the prior week. That has made some analysts wary.

EEM jumped more than 20 percent from lows touched in mid-January to rise 6.4 percent in the first quarter for its best quarter since 2012. The ETF is still up more than 7 percent year-to-date, while the S&P 500 is up less than 2 percent and the German DAX is off more than 6 percent. Japan's Nikkei 225 is down nearly 11.5 percent for the year so far, tracking for its first negative year since 2011.

"It's a very powerful rally but it doesn't look like investors have bought into it," said Geoff Dennis, head of global emerging markets equity strategy at UBS. "If the general positive view were to continue there's quite a lot of money that could come in."