Evolution of Trading in Emerging Markets

Rapid advancements in the past 10 years have brought trading costs and liquidity between developed and emerging markets closer to parity than ever before. Here’s how trading technology is affording investors greater peace of mind when investing across the full market spectrum of emerging market equities.

Trading in emerging markets has never been an easy task, but looking back 10 to 20 years, it was quite a bit more challenging than it is today. Historically, the microstructure of emerging markets was characterized by lower liquidity, higher volatility, and wider bid-ask spreads compared to developed markets. Access was often restricted because many brokers had expertise limited to specific markets, which hindered their ability to navigate the diverse and complex dynamics of the broader emerging markets universe effectively. Execution channels in these markets was mostly limited to broker-dealer portfolio trading or high-touch cash desks, as traders lacked the advanced trading systems and technology available in developed markets, relying instead on outdated platforms and limited access to real-time data.

High-touch cash desk brokers would typically be used to trade large average daily volume (ADV) order flow as they would try to source natural offsetting block liquidity or utilize their company’s balance sheet to trade on risk. This required a significant amount of trust and well-established relationships, as shopping of your flow or information leakage could lead to significant trading costs when trying to move large positions. Not surprisingly, their specialized expertise came at a price, with cash desk brokers demanding higher commissions to reflect the value they brought to the process.

In the absence of any natural liquidity, program trading was really the only other viable option. Program trading is used to trade large baskets of stocks across multiple emerging markets while trying to minimize the impact on market prices. High volatility, lack of liquidity, depth of book, limited price discovery, limited visibility into auctions, and wide bid-ask spreads often contributed to significantly higher transaction costs. Therefore, it was equally, if not more, important to have well-established, trustworthy relationships with brokers who understood the complexities and dynamics of each emerging market, as traders were at the mercy of these brokers to execute their orders effectively in the market.

By the late 2000s, electronic algorithmic trading was gaining significant traction. Large broker-dealers, such as Morgan Stanley, began offering low-touch trading in emerging markets like Poland, the Czech Republic, Hungary, and South Korea as early as 2007-2009. Around the same time, alternative institutional block trading networks, such as Liquidnet, expanded into markets including India, Indonesia, Thailand, Turkey, and the Philippines between 2010 and 2013. Today, Liquidnet's "Liquidity Pool" covers approximately 60% of all MSCI-EM countries.. Broker-dealers have even started offering their full electronic algo suites across MENA markets as recently as five years ago. On average, most broker-dealers offer low-touch electronic access to at least 75% of MSCI-EM countries, with a few firms covering almost all of these markets.

The Impact of Technological Innovations

To provide some context, let's look at how trading in emerging markets has evolved over the past 15 years. In 2010, a full 95% of emerging market equity trades still required program trading or high-touch cash desks, as electronic/algo trading was still in its early stages. Fast-forward to 2024, and this distribution has shifted significantly, with approximately 55% of trades in APAC, Europe, and MENA emerging markets now executed through program and high-touch trading, versus 45% electronically. LATAM markets remain behind the curve as electronic trading has yet to gain traction in very illiquid markets like Chile, Colombia, and Peru.

These advancements in trading have led to tangible improvements in efficiency and cost savings. We’ve seen enhancements in technology across the board, leading to easier access, elevated liquidity, tighter spreads, and lower trading costs. To put it in perspective, we can look at Instinet’s Global Execution Cost Monitor for MSCI-EM. Comparing the quarter ended September 2015 with the quarter ended September 2024, execution costs¹ in emerging markets have seen a notable decline, dropping from 20.8 basis points to 16 basis points, a decrease of 23%. Average daily turnover has surged dramatically, from $20.2 billion to $73.3 billion, reflecting a staggering increase of 264%. In terms of average daily spreads, there was a 25% decrease from 15.5 basis points to 11.6 basis points. Meanwhile, volatility remained relatively stable, slightly decreasing from 257.6 basis points to 240.8 basis points, a reduction of 7%.

Emerging market small-cap equities have similarly seen tighter spreads, lower trading costs, and elevated liquidity over recent years. Here we use the constituents of SPDR™ MSCI Emerging Markets Small Cap ETF as the universe, comparing data back to January 2018. Over this period, spreads have come down from 100bps to 37bps, a decline of 63%. Over the same period, average daily turnover has increased from $279.5 million to $496.2 million, an increase of 78%, with volatility remaining stable in the low 30s (with the exception of a spike during peak Covid).

Size, Scale, and Experience Can Offer Tangible Benefits

By virtue of our position as one of the largest global asset managers and our strong foothold in the emerging markets asset class, State Street Global Advisors has been one of the primary beneficiaries of this evolution. Looking strictly at Implementation Shortfall strategy trading, over the last three years State Street has executed 64% of our emerging market trades electronically (algo/wheel). This is mainly driven by tighter average spreads in our algo/wheel trading activity (15.97bps) versus non-algo trading (20.83bps), and has also resulted in lower transaction costs (20.2bps for algo/wheel versus 46.4bps in non-wheel activity). The evolution and blend of all these different execution channels drives costs lower: State Street has 38% lower implementation costs versus its peers in emerging markets trading over the last 14 quarters (see Figure 2 below).

The Bottom Line

There is little doubt technology and innovation have had a profound impact on efficiency and productivity over the last half century. While trading in emerging market equities may have been late to the game when compared to their DM peers, rapid advancements in the past 10 years have brought trading costs and liquidity between the two universes closer together. This offers increased flexibility to asset owners in allocating capital to the asset class and increased easy and capacity for managers to execute strategy objectives, driving improvement in overall efficiency through scale. Leaving the asset allocation decision aside from a tactical perspective, now is one of – if not the – best time to invest in emerging market equities from a trading efficiency perspective, and we expect technology enhancements to continue to play a key role in improve trading efficiency in the years to come.

Contributors:
Christopher N Laine
Senior Portfolio Manager

John G Siegrist
Senior Portfolio Manager

Nathaniel N. Evarts
Managing Director, Trading