Can emerging markets thrive?

MANAGERS: HAMPERED BY INEFFICIENCIES

They are more inefficient and therefore the opportunity to exploit those inefficiencies is greater.

Countries have idiosyncrasies that affect how likely it is that active management will be able to extract value.

It has largely become received wisdom that it is easier for active managers to outperform in emerging markets. The argument is that emerging markets are more inefficient than developed markets, and therefore the opportunity to actively exploit those inefficiencies is greater.

This argument is rarely scrutinised. Analysis by Citywire, however, suggests investors should perhaps be approaching this argument with more discretion than it generally receives.

The Citywire research compares the performance of equity managers with broad emerging market mandates, with those investing in only one of the seven largest constituents of the MSCI Emerging Markets Index (excluding Russia). The results are revealing.

Citywire’s analysts looked at which of these funds showed a risk-adjusted performance ahead of their benchmarks. The statistics show more than two-thirds of global emerging market managers have underperformed the index. This does not support the idea that this is a space in which active managers have a clear advantage.

But the picture is different when looking at specific countries. In Brazil, more than three-quarters of managers outperformed. A majority of managers also beat the index in Taiwan and China.

The performance of managers in SA, however, is the weakest among the analysed countries. This suggests two things:

The first is that the opportunity for outperformance in emerging markets is far from uniform. These countries have idiosyncrasies that affect how likely it is active management will be able to extract value.

In SA, the concentration of returns in a few large counters and the relative illiquidity in the majority of mid- and small-cap stocks has made outperformance increasingly difficult.

The relatively high involvement of institutional investors in the JSE also leads to higher levels of efficiency than for many of its peers.

Organisation for Economic Co-operation and Development figures show the level of institutional stock market ownership in Brazil is much lower than locally. In China, it’s lower still. This leads to very different opportunities in these markets.

The second consideration is that global emerging market funds appear to be at a disadvantage to funds focused on particular countries. This suggests the ability to exploit opportunities in emerging markets may also be dependent on local expertise.

As Gandy Gandidzanwa, managing director of Conceptual Fund Managers, told Citywire: “Emerging markets like Brazil, China, India or the greater Pacific Rim still have proportionality lower levels of institutional domestic investors.

“The bulk of the markets would be taken up by retail investors or foreign investors who do not have as much detail about what is happening domestically.

“So we believe there are opportunities for active, on-the-ground asset managers to benefit from an information advantage.”

Patrick Cairns is SA editor at Citywire