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 Emerging market bond and equity funds received heavy inflows in January after a dry patch last year, aided by China's reopening and softening inflation pressures worldwide.

According to Refinitiv Lipper data, which covers over 33,700 emerging market (EM) funds, EM equity funds received $13.2 billion, and EM bond funds obtained $11.36 billion in January. Both the inflows were the highest in over a year.

Fund flows: EM equities and bonds

In 2022, EM bond funds faced a combined net outflow of $26.26 billion.

Analysts expect cheaper valuations, a weakening dollar, peaking Fed rates pricing, and lower U.S. Treasury yields to bolster EM assets this year.

MSCI Emerging Markets and World Index's PE

"Even as global growth slows, we believe EM equity valuations have room to improve in 2023, driven by lower inflation, a peaking U.S. dollar, greater clarity around key political events, and structural shifts within the region," Josh Rubin, portfolio manager at Thornburg Investment Management.

"Taiwan and Korea should be beneficiaries of a recovery in the semiconductor and hardware technology sectors. Brazil could be the first major EM outside of China to enter an easing cycle next year."

According to Refinitiv data, emerging market firms are expected to post 11.9% profit growth in 2023, much higher than U.S. firms' growth of 8.9% and European firms' -2.2%.

In January, the iShares Core MSCI Emerging Markets ETF and iShares JPMorgan USD Emerging Markets Bond ETF received $3.2 billion and $2.4 billion, respectively, while iShares MSCI Emerging Markets ETF and BlackRock Emerging Markets Fund; Inst obtained over $1 billion each.

Biggest capital inflows into EM funds in Jan 2023

The MSCI Emerging markets index is up about 6% this year, but the index's forward 12-month is still trading at a 22% discount to the MSCI World index.

The JP Morgan EMBI + index, which tracks liquid, US dollar emerging market fixed and floating-rate debt instruments issued by sovereign entities, has risen 3.34% this year after declining about 25% last year.

"We see value in EM sovereign bonds, especially in some of the larger sovereign issuers that can work with the IMF or other international lenders, or where we see upside to potential restructuring scenarios," said UBS in a note.

Jason Pang,  a fixed-income portfolio manager at J.P Morgan Asset Management, said he is bullish on Indonesian and Malaysian government bonds as their central banks look to wind down their monetary tightening due to easing inflation pressures.

However, a few question if the rally in emerging assets is sustainable. Initial euphoria over China's reopening has fizzled out and EM assets have seen slight declines in February.

"Given the strong start to the year, we believe the bar is high for a continued rally in EM at the pace of the past two months, given China reopening and Fed deceleration are largely known quantities at this point," said Komson Silapachai, vice president at Sage Advisory Services.

"If markets started to price in a higher probability of recession, EM risk assets would not be immune."