It’s a debate that’s been running since the dawn of passive investing: Do you make more money by hiring researchers to analyze stocks and bonds — or are you better off sticking to indexes?
When it comes to emerging markets, turns out it’s the former. Active managers of at least $100 million returned an average of 4.8% a year for the three years ended on March 3 after fees, beating the 2.5% provided by their passive peers, a Bloomberg News analysis of U.S.-based funds shows. It makes sense on a gut-check level, too. In an investing universe where Argentina is flirting with its ninth default and Lebanon’s sky-high bond yields reflect political chaos, risk analysis is inescapable.
“An active approach in emerging markets is the one that works,” says Alastair Reynolds, who co-manages $3.6 billion of emerging-market assets at Martin Currie Investment Management in Edinburgh, Scotland. “It’s not like a beauty competition in the index. In emerging markets, you’re getting exposed to the best and the worst.”
Funds run by active managers also outperformed passive peers over five- and 10-year annualized periods, net of fees, the same Bloomberg analysis found.
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Although many global investors flock to cheaper, passive strategies that track benchmarks, they need to be more precise in emerging markets, where risks are amplified, says Jennifer Gorgoll, a money manager who specializes in corporate debt from the developing world at Neuberger Berman in Atlanta.
“You have a universe that’s growing so quickly,” says Gorgoll, who helps manage $26.2 billion. “You really need to do the work on the companies to understand what they do, the management teams, the financials, their performance and track record.”
It’s the inefficiencies in emerging markets that make an active strategy interesting, says Gaurav Mallik, chief portfolio strategist at State Street Global Advisors, which oversees more than $100 billion in emerging equity and debt.
“You have a lot more juice to exploit in those markets,” Mallik says. Higher liquidity and lower fees steer more global investors into index-driven strategies in the U.S. and Europe, but frictions in market access and local currency differentials in emerging nations are where value hides. Individual emerging company stocks and bonds also tend to be insulated from macro risk sentiment, he says.
“The countries and indexes at a high level face the bulk of the pressure,” Mallik says. “Individual stocks lying underneath those — and the deeper you go and less liquid the stocks — those don’t feel the same waves of money coming in or leaving.”
Passive ETFs — such as the iShares MSCI Emerging Markets ETF (EEM) — are often among the first to feel the pain of investors fleeing risky emerging markets for safer assets. When an outbreak of novel coronavirus stoked fears that the illness could hobble global growth, the fund plummeted.
In a telephone interview from San Diego, Kunal Ghosh, who manages about $2.3 billion at Allianz Global Investors, named producers of the popular Chinese liquor baijiu, as examples of value in active strategies. Alcohol beverage companies such as Wuliangye Yibin and Kweichow Moutai are the type of stocks that, he says, will benefit from a rising middle class and, therefore, more discretionary income.
The 20 top-performers are largely comprised of low-cost tech offerings.
Gaming company NetEase and education companies such as New Oriental Education & Technology Group are other examples of stocks gaining market share as consumers spend more time in front of screens and prepping for increasingly white-collar careers, Ghosh says. “Being active lets you focus on capturing the habits of the consumer, irrespective of how they’re represented in the index,” he says. “If you are hugging the index, what you’re doing is leaving ample opportunities of making extra money.”
Martin Currie’s Reynolds points to equities entwined in global supply chains, such as semiconductor and computer memory stocks and companies specializing in electric car parts in China or Korea. In corporate debt, Neuberger’s Gorgoll says she likes bonds sold by Chinese property companies or by Brazilian protein exporters. High-yielding notes from developing-world telecommunication or metals and mining companies are also attractive as infrastructure increases, she says.
Even MSCI, whose emerging-market equity and currency gauges are among the most watched by investors, agrees. The number of decisions an investor must make skyrockets when they enter emerging markets, and that’s where they can differentiate from the index, says Abhishek Gupta, vice president for equity solutions at MSCI.
“Accessibility and liquidity are what cause potential mispricing and give the active manager the opportunity,” says Raina Oberoi, who heads equity solutions research for the Americas at MSCI in New York. That’s where investors can get to know a company and find opportunities that the rest of the market doesn’t know, she says.
In addition, active funds can more easily adapt to changing investment trends, such as the push for ventures that account for ESG, she says. Still, it takes skill.
“Emerging markets are, compared to their developed — market counterparts, more risky,” Oberoi says. “You could pick the winners and do really well — or you could pick the losers and actually turn out worse.”
