Since 1988, equity returns in emerging markets (EM) have been reliably robust compared with the equity market as a whole (see Figure 1). Although a few emerging economies are in recession, and others are currently teetering, these consistently strong earnings suggest a continued opportunity for investors.
An analysis by State Street Global Advisors suggests, however, that many investors are encountering challenges as they attempt to take advantage of that opportunity. According to our analysis, index investors in emerging markets have realized negative excess returns on average (gross of fees) over the past ten years, while incurring alarmingly high tracking error in the range of 1% or more.
Why is this the case? Investing in emerging markets encompasses risks beyond pure investment risk, including foreign-exchange risk and liquidity risk. In addition, trading costs are far greater in emerging markets than in developed markets. Investing with a manager that has broad capabilities in trading, liquidity and transaction-cost management can help mitigate these risks.
Not all active EM managers are built the same. Because emerging markets are nuanced and constantly changing, we think that experience tends to pay off. Since 2002, the percentage of active managers beating the MSCI EM index has declined steadily, reaching a low point as of December 31, 2018 . In our view, consistent (if modest) alpha generation is more likely to pay off in the long term than a few, relatively isolated episodes of outstanding performance. One way to measure this consistency is to look at a manager’s performance on a rolling three-year or five-year basis. If a strategy has beaten its benchmark over 70% of the time since inception, we believe that is demonstration of true skill.
1 Source: eVestment, State Street Global Advisors. Strategies under eVestment Global Emerging Markets Large Cap Core and Global Emerging Markets. Large Cap universes were used to do this analysis. Only managers that report gross of fees returns were used in this analysis.
Foreign exchange risk: Foreign exchange risk describes the risk that an investment’s value may change due to changes in the value of two different currencies.
Liquidity risk: Liquidity risk is considered a type of market risk. It describes the phenomenon of opposing market participants (buyers and sellers) that are unable to find one another in a timely manner. Since no trade can be made, buyers may have to raise their bids or sellers may have to lower their asks to exchange an asset.
Emerging Markets: 23 emerging economies: Brazil, Chile, China, Colombia, Czech Republic, Egypt, Greece, Hungary, India, Indonesia, Korea, Malaysia, Mexico, Peru, Philippines, Poland, Qatar, Russia, South Africa, Taiwan, Thailand, Turkey and the United Arab Emirates.
Important Risk Information
All the index performance results referred to are provided exclusively for comparison purposes only. It should not be assumed that they represent the performance of any particular investment.
Investing in foreign domiciled securities may involve risk of capital loss from unfavorable fluctuation in currency values, withholding taxes, from differences in generally accepted accounting principles or from economic or political instability in other nations.
Investments in emerging or developing markets may be more volatile and less liquid than investing in developed markets and may involve exposure to economic structures that are generally less diverse and mature and to political systems which have less stability than those of more developed countries.
The views expressed in this material are the views of our Active Quantitative Equities team through the period ended March 11, 2019 and are subject to change based on market and other conditions.
This document contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected.
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Exp Date: 3/31/2020