Do active managers in Emerging Markets add Value?

Key Points

  • Emerging Markets (EM) have been outperforming Developed Markets (DM) and this trend is likely to continue given the fundamental backdrop.
  • Factor premiums across EM have been very strong and broad-based.
  • Intra-market correlations between EM countries have dropped, however unexpected macro-surprises could unsettle this dynamic.
  • Volatility levels across major EM markets are at their lowest points since 2002 but not in Russia and Brazil.
  • The median active manager has delivered positive active returns against the challenging and contrasting market backdrop. Over the past 10 years, a median active manager has added 1.53% p.a. while the first quartile manager has added 2.5% p.a., before fees.
  • Over the shorter-term periods, divergence in performance of active managers (top quartile less bottom quartile) has been almost 400% higher than the spread observed over the past decade.

EM outperformance likely to continue

Since September 2016, EM has been outperforming DM on a rolling 12-month return basis. The returns have been broad-based with countries like Poland, Hungary and Greece and China leading the pack. We believe the EM outperformance of DM is likely to continue given the superior fundamental (value and growth) backdrop of emerging market companies.

Factor Premiums in Emerging Markets have been very strong and broad-based.

Value, Growth, Size, Momentum and Quality style factors have all experienced positive returns. Beta was the worst performing factor over the past 12 months for example. High levels of factor return correlations are not unexpected during the early phases of a market recovery. That said, as the EM cycle advances, we expect factor premiums to diverge and ultimately opening way for strong outperformance from style-biased active managers.

Volatility levels across major markets are at their lowest points since 2002

Since the GFC, volatility levels across the EM countries have converged. Major countries like India and China, and regions like Asia, are at the lower end of the historical volatility range. By contrast, recent volatility in Brazil and Russia remain elevated based on historical standards. The volatility levels observed in EM continues to be much higher than the volatility observed in DM

Inter-market correlations are down but China is an outlier.

Country-specific correlations to overall MSCI EM Index have subsided in India, Brazil and Russia, for instance. Correlation of the Chinese equity market has continued to rise steadily and remain high at 82 percent. With an increasing exposure to Chinese equity market in the MSCI EM Index, this correlation is likely to rise further and has potential risk implications for managers betting against Chinese stocks.

Active managers have done well amongst this backdrop.

The median active manager has delivered positive active returns against the challenging and contrasting market backdrop. Over the past 10 years, a median active manager has added 1.53% p.a. while the first quartile manager has added 2.5% p.a., before fees. Over the past year, 3 years and 5 years, a median manager has added 1.30%, 1.74% and 1.88% p.a., respectively.

Over the shorter-term periods, divergence in performance of active managers (top quartile less bottom quartile) has been almost 400% higher than the spread observed over the past decade. Over the past 10 years, we also observe that the number of managers in the eVestment EM index has risen by 250%.