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Emerging markets gaining favor despite China concerns

The hunt for yield is driving investors back into emerging markets – but there are a few key differences this time round.

Emerging market equities, measured by the MSCI Emerging Markets Index, are now 30 percent up from the low seen at the end of January, and have rallied by 13 percent since the post-Brexit referendum sell-off.

Plus, in the past five weeks, record amounts of money have been invested in emerging market debt, according to figures from Bank of America Merrill Lynch.

These assets are traditionally perceived as riskier bets than more established markets. Still, with a low to negative interest rate environment across the Western world, and plenty of liquidity in the market, investors are looking outside safe havens.

However, there are still plenty of nasty surprises which could spark another sell-off such as an earlier-than-forecast hike in interest rates the U.S. Federal Reserve or a bonds market rout in the established markets.

"We see scope for the markets to run further still over the near-term," strategists at UBS wrote in a research note. However, there is plenty of differentiation within the asset class – and the big four of Brazil, Russia, India and China aren't always the center of attention.

In spite of this revival of interest in emerging markets, the popularity of Chinese assets seems to have declined as concerns about the health of the world's second largest economy continue. Investors reduced their positions in Chinese assets by more than in any other emerging markets economy in June, according to EPFR Global. Around $25 billion of capital per month is being taken out of China, according to Capital Economics research.


"There's a big question mark over whether they can rebalance towards a more consumption led growth model," Will Ballard, head of emerging market and Asia Pacific equities at Aviva Investors, told CNBC.

"You can see consumer price inflation picking up a bit, within services and that is a positive."

There was also a pivot away from India, although the country remains one of the most popular in emerging market funds.

Russia, which has struggled in recent years after the oil price plunged and the West enacted a series of economic sanctions against it, is expected to return to positive growth later in the year, although it will be "slow-going", according to William Jackson, senior emerging markets economist at Capital Economics.

Brazil – which is currently in the Olympics spotlight – is also attracting optimism. This is not because of the expensive and controversial Games, but more as the new President Michel Temer pushes through much-needed reform.

Within the smaller emerging market economies, Indonesia is attracting attention. "They've been able to lower rates, bring in a tax amnesty, push through more favorable policies, and you can see the domestic environment improving," Ballard said.