Investor appetite for risk assets has dwindled lately amid talks of a tapering of monetary stimulus in the US and potential military action in Syria.

Emerging market funds have taken a particular beating – investors worldwide pulled $4bn from emerging market equity funds and $2bn from emerging market bond funds last week, marking 14 consecutive weeks of outflows.

Why the recent sell-off?

The recent sell-off was already underway before the Federal Reserve started to talk of slowing down its quantitative easing programme. Emerging markets had already started to slow down as exports fell and governments began to reach the limits of providing fiscal and monetary stimulus.

Putting it bluntly, capital had begun to flow out of emerging markets back to the US just as emerging economies were most vulnerable to this sort of capital reversal.

The result has been severe pressure on emerging market currencies, particularly the Brazilian real and the Indian rupee. This in turn has forced Central Banks to tighten policy, against the needs of the domestic economies.

Even the emerging economies with relatively strong long-term underlying fundamentals were not immune from the sell-off. Markets with large current account deficits which need to be plugged by foreign money such as India, Turkey, Indonesia and Brazil were particularly penalised.

Another Asian crisis?

As a result, many investors are now querying the thesis that superior long-term growth, coupled with better governance, can lead to sustained outperformance by emerging market assets, with some now fearing a repeat of the Asian crisis of the late 1990s.

But Jeff Chowdhry, head of emerging market equities at F&C Investments, says investors should remain optimistic.

“Every few years, emerging markets go through a ‘crisis of confidence’ as investors worry either about politics or economics,” he says.

“We have had the Mexican, Russian, Asian crisis and most recently the global financial crisis. The common theme has been that emerging markets have gone down a lot and underperformed developed markets and subsequently rebounded to regain all their losses to make new highs.

“The ‘crisis’ this year is no different. Investors are worried about slow growth in emerging markets and current account deficits in countries such as India, Indonesia and Turkey which has led to sharp falls in their respective currencies.”

Should investors pull out of emerging markets?

Experts say that in the short-term, emerging markets will continue to struggle, with further potential hurdles still to overcome such as when the US does finally start to taper-off QE, as well as unforeseen shocks from political forces or unexpected poor performance in market data.

However, the consensus is that there are still opportunities for investors who can handle the heat as these markets are going through a cyclical adjustment rather than a long slog in bear territory.

Andrew Swan of BlackRock, the fund group, says that the huge outflows from emerging markets could translate into buying opportunities for savvy long-term investors: “Asian markets that saw the largest capital inflows are now suffering the most. However, this puts equity valuations below their long term averages making for an attractive entry point for long term investors.

“There are profound changes taking place in consumption, income growth and demographics which are reshaping the investment landscape in Asia. For some Asian economies, the historic investment-led growth dynamics of the past are fading. While in other parts of the region the demand drivers of growth are increasingly being supported by domestic demand, enhanced incomes and growing young populations, creating abundant investment opportunities.”

Investors should also note that while slowing investment within China will hit countries like Chile, which is largely dependent on demand from the Asian powerhouse for its metal exports, a slowdown could benefit the likes of India which is a net importer of commodities. In that sense, one country’s slowdown can benefit another within the emerging market space.

What happens when the US starts tapering QE?

When the US does start tapering QE, the impact may not be as drastic as some suggest.

Jan Dehn, head of Research at Ashmore says: “Emerging markets are not materially impacted by tapering. The vast bulk of QE money has gone into developed markets, where it has caused government bond prices and equity prices to soar relative to emerging markets. This is why debt ratios have remained stable in emerging markets throughout the QE years, while debt levels have increased from 80% to 110% of GDP in the developed world over the same period.

“Besides, emerging markets now comprises 65 countries with enormous variation. The differences between the largest and the smallest, the richest and the poorest, the least and the most indebted, the range of macroeconomic policies, the variety of structural characteristics and political realities are far, far greater than, say, the differences between Greece and Switzerland, or the US and Japan.”